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Basic Option Strategies: Short Put Option Strategy (Part 4)

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In this article, we take a look at Short Put, the last option strategy in our Basic Options Strategies series. We have covered the other 3 option strategies Long Call, Short Call and Long Put in our previous articles about Basic Options Strategies.

About Short Put Strategy

Short put means to sell a put option. Option traders use short put when they expect that the price to go up before the option expiration date (American-style) or at the expiration date (European-style). The graph above shows that if the underlying asset is below the strike price at expiration date, the seller will have unlimited loss. However, if the price expired at or above 1,640, the maximum profit the put seller can earned is the premium he received.

Like short calls, short puts are very risky since you can lose big if the underlying asset moves against you. Despite the unlimited risk, selling a put option is a great way to buy an underlying asset as a short put locks in the purchase price of the underlying asset at the strike price. You also make a profit as you receive a premium because of the selling.

The calculation formula for short put strategy is as follows:

[(Strike Price – Market Price at Expiration) x Contract Size ] + Premium Received

This chart and table illustrates the profit and loss assumptions for different market prices at the expiration date.

Short Put

DETAILS ASSUMPTION
Option Product FBM KLCI Index Option (OKLI)
Underlying Asset FBM KLCI futures (FKLI)
Current Market Price E.g ≥ 1640
Strategy Sell 1 Lot of OKLI at RM 1,640 (The Strike Price)
Call Option at RM20 (The Premium)
(In-the-money)
Premium = Premium Received x Contract Size
= RM20 x 50
= RM 1,000
Breakeven Point RM 1,620

IF MARKET PRICE AT EXPIRATION IS: PROFIT/LOSS ASSUMPTION
1580 = [(1640 – 1580) x 50] – RM 1,000
= RM 3,000 + RM 1,000
= RM 2,000 (Net Profit)
1620 = [(1640 – 1580) x 50] + RM 1,000
= RM 1,000 – RM 1,000
= RM 0 (No Gain or Loss)
1660 * If Market Price at Expiration is at or above 1,640, the maximum profit the put seller can earn is the premium he received.

 

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In the next article, we will discuss about factors you should consider when choosing the right option strategy.

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This article is contributed by Wan Zuraiha Zakaria and Jeremy Lim, both of whom are staff writers at Oriental Pacific Futures (OPF). OPF is a futures and options broker based in Kuala Lumpur, Malaysia and provides electronic trading, brokerage and clearing services to retail and institutional traders since 2007. OPF is licensed under the Securities Commissions of Malaysia and offers cash-settled derivatives instruments traded on Bursa Malaysia, as well as select major derivatives exchanges around the world.

Oriental Pacific Futures articles published on the Corporate Website (www.opf.com.my) may be reprinted, reposted or distributed free for educational purposes only on the condition that Oriental Pacific Futures and the Corporate Website link information http://www.opf.com.my are included. However, other organizations are invited to link to articles that are available in the public area of the Oriental Pacific Futures’ Learning Resources website. No additional permission is needed for such a link.

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