Can an option buyer have unlimited risk?
Suppose an option buyer buy 35000 CE for Jan, monthly expiry for 10 lot
which was trading at 1000, and now that 35000 CE becomes ITM, and has value of 3200 for 10 lot
and he decides hold until 30th of Jan
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As Index options are cash settled, the maximum amount a option buyer can lose is the premium. In the example you cited, the buyer will be in a profit and even if you don’t sell it at expiry, you will receive the profits.
A stock option buyer can potentially have a very large risk if the option expires ITM and they don’t have the required no. Of shares in the demat to deliver or buy as per the case.
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Thank for your information,
I hope you heard of hindalco put option buyer where he made huge loss,
How this put buyer could avoid this loss?
- Exiting 1 day before expiry
- Take delivery means, (create sell position and hold it) for next expiry ??
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Yes, if he had sold the put option he could have avoided the loss. In this case he said that there were no sellers, even at very near to atm strikes, which tells us how important it is to trade fnO only with the most liquid stocks. Therefore, he was forced to hold it till expiry.
Definition of put option:
A put option is a contract that gives its holder the right to sell a number of equity shares at the strike price , before the option’s expiry. If an investor owns shares of a stock and owns a put option, the option is exercised when the stock price falls below the strike pric he sells the stock and makes profit through the option.
In the above case, as he had bought put option and when it closed ITM, he had to sell the equal number of shares to the lot size of hindalco. As he failed to do that, it must have been short delivery and then been purchased by broker in auction market and delivered to the person who sold the put option.
Take delivery means, (create sell position and hold it) for next expiry ??
No, it means you pay the cash for buying the no. of shares equal to the lot size of the stock.
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Earler there was an option of Do not Exercise for CTM options, It was removed in October,
With this change, if you have bought an option and it expires ITM, then the obligations arise for Option buyers also.
Index options are cash settled based on Intrensic value at expiry. The case you are refering is applicable to Stock options - such as Hindalco as you have referred.
Could have exited on the day of expiry also, based on liquidity.
A put buyer has to Give delivery ( as put seller will take delivery by paying cash). If the shares are not there in the holding, then it will be purchased in auction and then will be given as delivery (for the put buyer)
lets suppose If that guy had that much of cash in his dmat account, money would have been blocked and how much loss could he save then ?
His losses would be almost same, he could have saved only on debit balance charged by the broker.
Here you have to understand that broker is purchasing the shares in auction market at a higher price (480) and selling at strike price (450) , that itself is about 5% loss.