Suppose the investor purchased a stock put option with an exercise price of $100, an expiration date of three months, and paid a premium of $2. If the stock price falls to $90 within three months, the investor can exercise the option and sell the stock at $100, earning $10. Since the investor has paid a premium of $2, his net gain is $8.
However, if the stock price is still above $100 after three months, the investor can choose not to exercise the option and lose only the $2 premium he paid. This strategy enables the investor to gain if the stock price falls, while losing only the premium paid if the stock price rises or remains unchanged.
Judgment basis: When the market falls, you can earn profits from the decline in the price of the underlying securities.
Profit and loss situation:
- Maximum profit: Very large, but with an upper limit, that is, the stock price drops to zero yuan
- Maximum loss: option premium
- Breakeven point: Strike price – option premium
Volatility: An increase in volatility is positive, and a decrease in volatility is negative.
Time reduction: negative effects
3. Selling Call Options (Short Call )
The strategy of selling call options means that investors sell a call option contract and hold an equal number of shares of the underlying stock at the same time. It is suitable for investors who are optimistic about the underlying stock but believe that the market may enter a small volatile market before the option expires.
It is the right given by a sold option contract to the option buyer to buy the underlying asset at a specific price on or before the expiration date. The holder of a sold call option believes that the price of the underlying asset may fall or remain stable, thereby hoping to earn the option premium while facing possible future losses.
For example, let’s say Company XYZ’s stock is currently trading at $100. You believe the company’s prospects are stable or declining and the stock price will not rise above a certain price, so you sell a call option expiring three months in the future with a strike price of $110 for a $3 premium.
If the price of XYZ stock does not rise to $110 or above before the option expires, the option buyer will not exercise the option and you will receive the $3 option premium while keeping the XYZ stock. If the price of XYZ stock rises to $120 before the option expires, the option buyer will exercise the option and you will need to buy XYZ stock at $110 and sell it at the current market price of $120, thus facing a loss of $10 per share (minus the $3 option premium you received).
Selling call options has limited gain and unlimited loss potential because the price of the underlying asset may rise above the strike price before the option expires, causing the holder to purchase the underlying asset at a higher price or face higher losses. Therefore, selling call options is a high-risk, high-reward option trading strategy that requires in-depth knowledge and risks of option trading.
