It is important that you also understand how Put options work before moving into more complex option definitions and advanced trading strategies. As Puts and Calls are reflections of each other, this lesson will read very similar to the last one on Call options but it is important that you understand the difference between the two types of option trades.
A Put gives the holder the right, but not the obligation, to sell at an agreed upon price up until expiry.
The agreed sell/buy price available to an option holder is called the strike rate. An option buyer will benefit if the strike rate can beat the market! If you are holding a Put option, the strike will become more attractive as the market falls.
Let’s look at a scenario where the buyer (holder) of an option on the EUR/USD might buy a put option expiry in 11 days* for the premium of 165 USD assuming the current strike price of the call option is at 1.2300 for the amount of 20K. *The markets are closed on Holidays, so the expiry choices closest to 7 days are 5 or 11 days.
It is important to note that the premium of a buy Put trade increases as the market falls. Why? Because the Put's strike rate becomes more attractive relative to the market rate.
For now, let’s look at two possible results for the buyer in the above scenario:
1. The market price for the EUR/USD goes below 1.2237 (break-even point) before 11 days expire: The buyer will sell the option at a higher premium and profit from the difference. If on expiry the rate is 1.2077, they make a profit from the difference between the cash flow at expiry and the premium at open equaling 320 USD, as seen below. Alternately, if you are the seller (writer) of the option in this case, you have lost 320 USD.
2. The market price does not go below 1.2237: The buyer is not going to exercise their option as option’s buyers have the right, but not the obligation, to exercise their options. So, even though the option buyer bought the option, they never have to exercise it! This means the buyer is out the value of the option premium and the seller gains the value of the option premium, in this case 165 USD. Unlike with the direct purchase of an underlying asset, options buyers are only obligated for paying the premium amount not the cost of the underlying asset until they exercise their options.
A Put gives the holder the right, but not the obligation, to sell at an agreed upon price up until expiry.
The agreed sell/buy price available to an option holder is called the strike rate. An option buyer will benefit if the strike rate can beat the market! If you are holding a Put option, the strike will become more attractive as the market falls.
Let’s look at a scenario where the buyer (holder) of an option on the EUR/USD might buy a put option expiry in 11 days* for the premium of 165 USD assuming the current strike price of the call option is at 1.2300 for the amount of 20K. *The markets are closed on Holidays, so the expiry choices closest to 7 days are 5 or 11 days.
It is important to note that the premium of a buy Put trade increases as the market falls. Why? Because the Put's strike rate becomes more attractive relative to the market rate.
For now, let’s look at two possible results for the buyer in the above scenario:
1. The market price for the EUR/USD goes below 1.2237 (break-even point) before 11 days expire: The buyer will sell the option at a higher premium and profit from the difference. If on expiry the rate is 1.2077, they make a profit from the difference between the cash flow at expiry and the premium at open equaling 320 USD, as seen below. Alternately, if you are the seller (writer) of the option in this case, you have lost 320 USD.
2. The market price does not go below 1.2237: The buyer is not going to exercise their option as option’s buyers have the right, but not the obligation, to exercise their options. So, even though the option buyer bought the option, they never have to exercise it! This means the buyer is out the value of the option premium and the seller gains the value of the option premium, in this case 165 USD. Unlike with the direct purchase of an underlying asset, options buyers are only obligated for paying the premium amount not the cost of the underlying asset until they exercise their options.
Editors’ Picks
EUR/USD meets support around 1.0650
EUR/USD managed to surpass the key 1.0700 barrier in response to the intense retracement in the US Dollar in the wake of the Fed’s interest rate decision and Chair Powell’s press conference.
GBP/USD rises above 1.2500 on weaker Dollar
The resumption of the upward pressure sends GBP/USD back above 1.2500 the figure in response to increasing selling pressure hurting the Greenback.
Japanese Yen struggles to gain momentum, eyes on Fed decision
The Japanese Yen continues to be undermined by the divergent BoJ-Fed policy expectations. Bets that the Fed will keep rates higher for longer, lift the USD, and lend support to USD/JPY. The risk-off impulse underpins the safe-haven JPY and caps gains ahead of the FOMC decision.
Editors’ Picks
AUD/USD: Extra gains in the pipeline above 0.6520
AUD/USD partially reversed Tuesday’s strong pullback and regained the 0.6500 barrier and beyond in response to the sharp post-FOMC pullback in the Greenback on Wednesday.
EUR/USD meets support around 1.0650
EUR/USD managed to surpass the key 1.0700 barrier in response to the intense retracement in the US Dollar in the wake of the Fed’s interest rate decision and Chair Powell’s press conference.
Gold surpasses $2,300 as Dollar tumbles
The precious metal maintains its constructive stance and trespasses the $2,300 region on Wednesday after the Federal Reserve left its FFTR intact, matching market expectations.
Bitcoin price reclaims $59K as Fed leaves rates unchanged
The market was at the edge of its seat on Wednesday to see whether the US Federal Reserve (Fed) would cut interest rates during the Federal Open Market Committee (FOMC) meeting.
The market welcomes the Fed's statement
The market has welcomed the Fed statement, and the S&P 500 is higher in its aftermath, the dollar is lower and Treasury yields are falling. There is still only one cut priced in by the Fed.
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