Question

A holder of a call option will want the value of the underlying asset to __________, and a writer of a put option will want the value of the underlying asset to _________.

A. decrease; increase

B. increase; increase

C. increase; decrease

D. decrease; decrease

Answer 1

A holder of a call option will want the value of the underlying asset to increase, and a writer of a put option will want the value of the underlying asset to increase

(B. increase; increase)

• Call Option gives its holder a right to buy an underlying asset at an agreed strike price/exercise price on the maturity date. The writer of the call option has the obligation to sell if the holder exercises his right.
• Put option gives its holder a right to sell an underlying asset at an agreed strike price/exercise price on the maturity date. The writer of the put option has the obligation to buy if the holder exercises his right.

• Option	Holder	Writer
  Call	Right to buy	Obligation to sell
  Put	Right to sell	Obligation to buy

• Situation	Call option	Put option
  FSP > X	Exercised	Lapsed
  FSP < X	Lapsed	Exercised

  • X = strike price or exercise price: the price agreed today for a transaction to take place on the maturity date
  • FSP = Future Spot price or Maturity Spot price is the price at which the share is actually trading on the maturity date

• Option	Holder	Writer
  Call	Bullish (Expects increase in price)	Bearish (Expects decrease in price)
  Put	Bearish (Expects decrease in price)	Bullish (Expects increase in price)

Illustration:

Strike price ($)	Actual future spot price ($)	Call option	Put option
190	210	Exercise	Lapse
200	190	Lapse	Exercise
370	400	Exercise	Lapse
400	450	Exercise	Lapse

*from option holder's perspective. The option writer has to fulfill the obligation when the holder exercises his option.