Derivatives - Managing Risk with Options Strategies: Long and Short Call and Put Positions
Let's look at a typical long call. Let's say it is 1 MNO May 100 call @ 3; essentially the spot rate for the stock has to rise above $103 ($100 strike price plus $3 premium) to be in the money. In fact, the option begins life at $3 out of the money because of the premium.
This graph reflects the point of view of the buyer. The view of the writer - who goes short when she sells a call - is a mirror image:
Long and Short Put Positions
Now let's look at puts. This example is a long put - a put from the perspective of the buyer. Similar to the previous example, let's say it is 1 MNO May 100 put @ 3; so essentially the spot rate for the stock has to sink below $97 ($100 strike price minus $3 premium) to be in the money. It does not matter how far above the strike price the spot price goes; if the option is going to cost the buyer more than the premium, he will simply let it expire unexercised.
Again, the writer's perspective - the short position - is just the flip-side of the buyer's perspective:
One quick point about premiums: by figuring them in, you determine the profit or loss from an option. This is different from the payoff. To figure the payoff, simply assume the premium equals $0.Managing Risk with Options Strategies: Covered Calls and Protective Puts