Question

1. What does it mean to be long an option. What are the implications of being long?

2. What does it mean to be short an option. What are the implications of being short?

Answer 1

Ans ) Option : Options are financial instruments that are derivatives based on the value of underlying securities such as stocks. An options contract offers the buyer the opportunity to buy or sell—depending on the type of contract they hold—the underlying asset. Unlike futures, the holder is not required to buy or sell the asset if they choose not to.

Long call options

The long call option strategy is the most basic option trading strategy whereby the options trader buy call options with the belief that the price of the underlying security will rise significantly beyond the strike price before the option expiration date.

Long Call Payoff Diagram

Long put

Payoff from buying a put

A trader who expects a stock's price to decrease can buy a put option to sell the stock at a fixed price ("strike price") at a later date. The trader will be under no obligation to sell the stock, but only has the right to do so at or before the expiration date. If the stock price at expiration is below the exercise price by more than the premium paid, he will make a profit. If the stock price at expiration is above the exercise price, he will let the put contract expire and only lose the premium paid. In the transaction, the premium also plays a major role as it enhances the break-even point. For example, if exercise price is 100, premium paid is 10, then a spot price of 100 to 90 is not profitable. He would make a profit if the spot price is below 90.

​​​​​​Short options

A short call option position in which the writer does not own an equivalent position in the underlying security represented by their option contracts. Making a short call is an options trading strategy in which the trader is betting that the price of the asset on which they are placing the option is going to drop.

Short Call Work?

A short call strategy is one of two simple ways options traders can take bearish positions. It involves selling call options, or calls. Calls give the holder of the option the right to buy an underlying security at a specified price.

If the price of the underlying security falls, a short call strategy profits. If the price rises, there’s unlimited exposure during the length of time the option is viable, which is known as a naked short call. To limit losses, some traders will exercise a short call while owning the underlying security, which is known as a covered call.

Short Put

A short put refers to when a trader opens an options trade by selling or writing a put option. The trader who buys the put option is long that option, and the trader who wrote that option is short. The writer (short) of the put option receives the premium (option cost), and the profit on the trade is limited to that premium.

Work of long option

TRADING  OPTIONS & DERIVATIVES TRADING

Long Put

By TIM SMITH

Updated Nov 13, 2019

What Is a Long Put?

A long put refers to buying a put option, typically in anticipation of a decline in the underlying asset. A trader could buy a put for speculative reasons, betting that the underlying asset will fall which increases the value of the long put option. A long put could also be used to hedge a long position in the underlying asset. If the underlying asset falls, the put option increases in value helping to offset the loss in the underlying.

Image by Julie Bang © Investopedia 2019

KEY TAKEAWAYS

• Investors go long put options if they think a security's price will fall.
• Investors may go long put options to speculate or hedge a portfolio.
• Downside risk is limited using a long put options strategy.

The Basics of a Long Put

A long put has a strike price, which is the price at which the put buyer has the right to sell the underlying asset. Assume the underlying asset is a stock and the option’s strike price is $50. That means the put option entitles that trader to sell the stock at $50, even if the stock drops to $20, for example. On the other hand, if the stock rises and remains above $50, the option is worthless because it is not useful to sell at $50 when the stock is trading at $60 and can be sold there (without the use of an option).

If a trader wishes to utilize their right to sell the underlying at the strike price, they will exercise the option. Exercising is not required. Instead, the trader can simply exit the option at any time prior to expiration by selling it.

A long put option may be exercised before the expiration if it’s an American option whereas European options can only be exercised at the expiration date. If the option is exercised early or expires in the money, the option holder would be short the underlying asset.

Long Put Strategy Versus Shorting Stock

A long put may be a favorable strategy for bearish investors, rather than shorting shares. A short stock position theoretically has unlimited risk since the stock price has no capped upside. A short stock position also has limited profit potential, since a stock cannot fall below $0 per share. A long put option is similar to a short stock position because the profit potentials are limited. A put option will only increase in value up to the underlying stock reaching zero. The benefit of the put option is that risk is limited to the premium paid for the option.

The drawback to the put option is that the price of the underlying must fall before the expiration date of the option, otherwise, the amount paid for the option is lost.

To profit from a short trade a trader sells a stock at a certain price hoping to be able to buy it back at a lower price. Put options are similar in that if the underlying stock falls then the put option will increase in value and can be sold for a profit. If the option is exercised, it will put the trader short in the underlying stock, and the trader will then need to buy the underlying stock to realize the profit from the trade.

Long Put Options to Hedge

A long put option could also be used to hedge against unfavorable moves in a long stock position. This hedging strategy is known as a protective put or married put.

For example, assume an investor is long 100 shares of Bank of America Corporation (BAC) at $25 per share. The investor is long-term bullish on the stock, but fears that the stock may fall over the next month. Therefore, the investor purchases one put option with a strike price of $20 for $0.10 (multiplied by 100 shares since each put option represents 100 shares), which expires in one month.

The investor's hedge caps the loss to $500, or 100 shares x ($25 - $20), less the premium ($10 total) paid for the put option. In other words, even if Bank of America falls to $0 over the next month, the most this trader can lose is $510, because all losses in the stock below $20 are covered by the long put option.