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If you are buying with and intention of closing an existing short position, then it is merely called a ‘square off’ position. The position is called ‘Long Option’ only if you are creating a fresh buy position. You buy intending to close an existing short position.You buy to create a fresh option position.Now here is another important thing to note, you can buy an option under 2 circumstances – Going by that, selling a call option and selling a put option is also called Short Call and Short Put position respectively.
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Likewise, whenever you sell an option, it is called a ‘Short’ position. Going by that, buying a call option and buying a put option is called Long Call and Long Put position respectively. It would help if you remembered that when you buy an option, it is also called a ‘Long’ position. Likewise, the put option buyer has unlimited profit potential, mirroring this the put option seller has maximum loss potential.įurther, here is a table where the option positions are summarized. The mirror image of the payoff emphasizes the fact that the maximum loss of the put option buyer is the maximum profit of the put option seller. Clearly, the pay off diagrams looks like the mirror image of one another. Finally, on the right, the pay off diagram of Put Option (sell) and the Put Option (buy) are stacked one below the other.The reason why I’m talking about volatility is that volatility has an impact on option premiums.
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Of course, there is an angle of volatility here which we have not discussed yet we will discuss the same going forward. You will not make money doing so, or in other words, you will certainly lose money in such circumstances. In other words, do not buy a call option or do not sell a put option when you sense there is a chance for the markets to go down. This is to emphasize that both these option variants make money only when the market is expected to go higher. We have placed the payoff of Call Option (buy) and Put Option (sell) next to each other.Likewise, the call option buyer has unlimited profit potential, mirroring this the call option seller has maximum loss potential. The maximum loss of the call option buyer is the maximum profit of the call option seller. The mirror image of the payoff emphasis the fact that the risk-reward characteristics of an option buyer and seller are opposite. If you look at the payoff diagram carefully, they both look like a mirror image. Let us start from the left side – if you notice we have stacked the pay off diagram of Call Option (buy) and Call option (sell) one below the other.Please find below the pay off diagrams for the four different option variants –Īrranging the Payoff diagrams in the above fashion helps us understand a few things better. For this reason, we will quickly summarize what we have learnt so far in this module. Hence before we get deeper into options, it is important to have a strong foundation on these four variants of options. Imagination and intellect is the only requirement for creating these option trades. Think of it this way – if you give a good artist a colour palette and canvas he can create some fascinating paintings, similarly a good trader can use these four option variants to create some outstanding trades. With these 4 variants, a trader can create numerous different combinations and venture into some really efficient strategies, generally referred to as ‘Option Strategies’. Further, we looked at four different variants originating from these 2 options – Over the last few chapters, we have looked at two basic option type’s, i.e.