I wont be able to explain it to u in nepali but I will try my best to explain in a nepali style ...
First
of all, option is a kind of a insurance against a expected or
unexpected price change of an underlying asset. It is like buying
insurance or selling insurance. Options give you a right to buy or sell
your asset at a predetermined price. Option could be used to hedge any
kind of security( equity, bond, currency, commodities...). Let me use
equity(stocks) to illustrate my example . Lets suppose you have 400
shares of Google Inc. each worth $400.
long call : you buy the right to buy a share at some price.
short call: you take a premium from someone playing long call and sell him a right to buy ur stock at a certain price.
long put: you buy the right to sell a share at a certain price.
short put: you take a premium from someone playing long put and sell him a right .
( I only have 2 examples..because I have exams tomorrow.... ask me questions if u have any..) I will answer it tomorrow..
(long call)
condition
1: lets suppose that google is introducing gphone next month and u
think it will beat iphone and will obtain 60% market share of touch
screen phones. but u arent sure. in that case u might wanna buy an
option that will give you a right to buy a share at a strike price.
lets suppose its $405. you pay $2 for a option. you pay $800 in total
as a premium. if the gphone is successful and the stock price goes to
425, you can buy the stock at $405( strike price) giving you $20 x
400=$8000 -($800 premium)=7200 profit. however, if it is not
successful, you lose your 800 dollars.
long put
Condition
2: u find out that a big company( example microsoft) is about to sue
Google inc for infringement of copyright issues. U are pretty sure that
Google inc. will have to pay a substantial amount of money to that
company if they lose the lawsuit. And Google will lose a lot of its
assests which will reduce their share value by 20%. you are not
hundred percent sure that Google will lose the lawsuit. In that case u
might want to insure your share from the possible decrease in share
value. you might buy an option( $2 PER SHARE) to sell your stock $400(
this is called strike price). In that case, if microsoft wins the case,
the price of google will go to 400-80=$320. but since you bought an
option to sell your stocks at 400, the person who sold you the option
will have to buy the stock at 400. you will be paying, $800 in premium
to protect a $32000 price decrease. however, if google wins the
lawsuit, and their stock value remain the same.. you will lose ur $800
Last edited: 03-May-09 11:34 PM
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