Put option
1.
An option which gives the holder the right to sell a specified quantity of a physical underlying asset, such as a commodity, at the strike price specified by the option.
The holder will only exercise the option if it is beneficial for the holder to do so, based on the difference between the strike price and the price of the underlying asset at the maturity of the option.
Example: Choices
- PUT options protect holders, or producers, of assets against falls in the market price of the asset.
- Say we hold 1m tonnes of an asset.
- We could buy a put option to sell 1m tonnes at $50 per tonne.
- The put option protects us against the market price falling lower than $50.
- It gives us the right to SELL 1m tonnes for $50m - IF WE CHOOSE TO DO SO.
- If the market price is lower than $50, we will EXERCISE our put option, and receive $50m in exchange for the asset under the option.
- If the market price is HIGHER, we’ll allow the option to lapse, and sell our asset in the market for the current market price.
- Hedging our position with the option establishes a MINIMUM “floor” value for our holding.
- In exchange for paying the up front option premium.
2.
A similar option over a non-physical underlying asset.
Cash settlement
In practice many options are cash-settled by a payment, if relevant, by the writer (or seller) of the option to the holder, at the maturity date of the option.
There will be a payment if the underlying asset price is favourable for the option holder, compared with the strike price of the option.
Options over non-physical underlying assets are always cash-settled.
Foreign exchange put options
A foreign currency call option is the option to sell a specified quantity of the base currency in the currency pair, at the strike rate specified in the option.
Interest rate options
'Lenders' options' hedge against a fall in interest rates.
For options over forward rate agreements, this is a put option.
Put options over short-term interest rate futures contracts are 'borrowers' options'.
These hedge against a rise in interest rates.
