Wednesday, December 23, 2009


Combinations of Put, Call and Share Options

Theoretically, an investor can from portfolio of options with any assets. In practice, stock options are most popular. A share, a put and a call can be combined together to create several pay off opportunities. Some of these combinations have significant implications.

Combination of share and a put option

A long position involves buying and holding shares or any other assets to benefit from capital gains and dividend.

An investor may create a long position in the shares of a firm. A long position investment strategy is risky.

The investor will incur loss if the share price declines. An investor will gain if the share price rises in the future. However, he will incur loss if the price in future turns out to be lower than the current price. An investor can however, guard himself against the risk of loss in the share value by purchasing a put option that has the exercise price equal to the current market price of the share.

Put option at the money is called a protective put. The combination of a long position in the share and a protective put helps to avoid the investor’s risk when the share price falls.

If the price of the share increases, the investor gains and the value of his portfolio at expiration will be equal to the share price.

The value of put to him will be zero since he will not exercise his options. On the other hand, if then share price falls, the value of the investor’s portfolio will be equal to the share price plus the value of the put option. Since the put was at the money when the investor sold it, the value of his portfolio will be at least equal to the share price at that time.

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