Bought Put Option Example:

Posted on February 19th, 2010 admin No Comments

Buy 1 contract CBA May 2500 Put option @ 180 cents

This option gives you the right to sell 1000 CBA shares for $25.00 each, on or before the expiry date in May. If CBA decreases strongly below $25.00 by expiry of the option, you have locked in a higher selling price for the shares.

As the buyer of the option, you have a choice as to whether you want to exercise and sell the 1000 CBA shares or if you just want to sell the option.

For example, if you are right in your assumption, and CBA falls to below $25.00 over this time, you have locked in a higher selling price for the 1000 CBA shares at $25.00. You could elect to exercise your option and sell the shares, receiving the full face value of $25.00 per share plus other fees and transaction costs that might be applicable. Also, the option premium you paid at the start for this option would be deducted from the $25.00 selling price, so the break-even on this trade will be decreased by this amount.

Alternatively, if you decide that you don’t want to sell the shares, perhaps you were interested only in participating in the decrease in CBA’s share price; you could sell the option and profit from the increase in premium.

Worst case scenario, should CBA increase above $25.00 over this time, your option would lose value. If CBA is above $25.00 at expiry, the option would expire worthless. Should you now want to sell the shares, you could sell them at a higher price in the market. Even though the initial premium paid might be lost, the increased sale price of the shares will at least partially offset this.

Trade Summary

 

Exposure 1000 shares

Initial Investment = $1,800

Max Loss = $1,800

Breakeven = $23.20

Max Profit = $23,200

 


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