Call On A Put

AAA

DEFINITION of 'Call On A Put'

One of the four types of compound options, this is a call option on an underlying put option. If the option owner exercises the call option, he or she receives a put option, which is an option that gives the owner the right but not the obligation to sell a specific asset at a set price within a defined time period. The value of a call on a put changes in inverse proportion to the stock price, i.e. it decreases as the stock price increases, and increases as the stock price decreases. Also known as a split-fee option.




INVESTOPEDIA EXPLAINS 'Call On A Put'

A call on a put will have therefore two strike prices and two expiration dates, one for the call option and the other for the underlying put option. As well, there are two option premiums involved; the initial premium is paid upfront for the call option; the additional premium is only paid if the call option is exercised and the option owner receives the put option. The premium in this case would generally be higher than if the option owner had only purchased the underlying put option to begin with.


For example, consider a U.S. company that is bidding on a contract for a European project; if the company's bid is successful, it would receive say 10 million euros upon project completion in one year's time. The company is concerned about the exchange risk posed to it by the weaker euro if it wins the project. Buying a put option on 10 million euros expiring in one year would involve significant expense for a risk that is as yet uncertain (since the company is not sure that it would be awarded the bid). Therefore, one hedging strategy the company could use would be to buy, for example, a two-month call on a one-year put on the euro (contract amount of 10 million euros). The premium in this case would be significantly lower than it would be if it had instead purchased the one-year put option on the 10 million euros outright.


On the two-month expiry date of the call option, the company has two alternatives to consider. If it has won the project contract or is in a winning position, and still desires to hedge its currency risk, it can exercise the call option and obtain the put option on 10 million euros. Note that the put option will now have ten months (i.e. 12 - 2 months) left to expiry. On the other hand, if the company does not win the contract, or no longer wishes to hedge currency risk, it can let the call option expire unexercised and walk away.

RELATED TERMS
  1. Put On A Put

    One of the four types of compound options, this is a put option ...
  2. Put On A Call

    One of the four types of compound options, this is a "put" option ...
  3. Call On A Call

    A type of compound option in which the investor has the right ...
  4. Put

    An option contract giving the owner the right, but not the obligation, ...
  5. Call

    1. The period of time between the opening and closing of some ...
  6. Compound Option

    An option for which the underlying is another option. Therefore, ...
Related Articles
  1. Options & Futures

    Getting To Know The "Greeks"

    Understanding price influences on options positions requires learning about delta, theta, vega and gamma.
  2. Options & Futures

    The Importance Of Time Value In Options Trading

    Move beyond simply buying calls and puts, and learn how to turn time-value decay into potential profits.
  3. Options & Futures

    Dividends, Interest Rates And Their Effect On Stock Options

    Learn how analyzing these variables are crucial to knowing when to exercise early.
  4. Options & Futures

    The ABCs Of Option Volatility

    The mystery of options pricing can often be explained by a look at implied volatility (IV).
  5. Mutual Funds & ETFs

    Are there publicly traded hedge funds?

    See why a privately arranged hedge fund may decide to take its fund public, and how the investing public at large can gain exposure to hedge fund value.
  6. Options & Futures

    What is spread hedging?

    Learn about one of the most common risk-management strategies options traders use, called spread hedging, to limit exposure to harmful stock movements.
  7. Options & Futures

    What role does intrinsic value play in put options?

    See why the concept of intrinsic value is so important in options trading and how investors use it to evaluate the worth of their options contract.
  8. Mutual Funds & ETFs

    What does a hedge fund do?

    Read how hedge funds differ from other investment vehicles and how their investment strategies make them unique and potentially risky.
  9. Mutual Funds & ETFs

    What is the difference between a hedge fund and a private equity fund?

    Learn the primary differences between hedge funds and private equity funds, both of which are utilized by high net worth investors.
  10. Mutual Funds & ETFs

    How do hedge funds determine what assets to own?

    Learn about the various types of investments that hedge fund managers use, and explore basic hedge fund management trading strategies.

You May Also Like

Hot Definitions
  1. Risk-Free Rate Of Return

    The theoretical rate of return of an investment with zero risk. The risk-free rate represents the interest an investor would ...
  2. Scarcity

    The basic economic problem that arises because people have unlimited wants but resources are limited. Because of scarcity, ...
  3. Trust Fund

    A trust fund is a fund comprised of a variety of assets intended to provide benefits to an individual or organization. The ...
  4. Christmas Tree

    An options trading strategy that is generally achieved by purchasing one call option and selling two other call options at ...
  5. Christmas Club

    A short-term savings account that usually pays out the full account balance to its account holders once each year, right ...
  6. Boston Snow Indicator

    A market theory that states that a white Christmas in Boston will result in rising stock prices for the following year. For ...
Trading Center