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Returns to Option Buyers and Sellers

 
 

  • Returns to Option Sellers
    • The price that the option writer gets for underwriting the contract is called premium
    • If the option is not exercised, the option writer makes profit from the premium
    • If the option is exercised, the option writer may make profit or loss depending on the spot price of the underlying asset at the time
  • Example: A Call option writer gets premium of 1 for an option with strike price of 5
    • He makes a profit if:
    • The option is not exercised when spot price is less than 5. The profit is 1 (i.e. premium)
    • The option is exercised and spot price is more than 5 but less than 6
    • The profit to the call writer is less than 1
    • If the spot price is 6, the writer has no profit and no loss
    • For all spot prices more than 6, the call writer makes losses, which increase linearly with increase in spot prices

Returns to Option Buyers

  • Profit to Option buyers:
    • The pay-off are distinct from the profit (or loss) to the option holder
    • To estimate the profit, the premium (price of option) is to be subtracted from the pay-off
  • Illustration: In continuation to above, further consider options which carries a premium of 1

Stock Price

Option Premium

Call
Value

Put Value

Strike Price

0

1

-1

4

5

1

1

-1

3

5

2

1

-1

2

5

3

1

-1

1

5

4

1

-1

0

5

5

1

-1

-1

5

6

1

0

-1

5

7

1

1

-1

5

8

1

2

-1

5

9

1

3

-1

5

10

1

4

-1

5

 

 





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