Reliance Naked Put Option
A Reliance Put Option at a strike price of Rs.1800 with expiry date 31-May-07 means a contract which gives the holder the right, but not the obligation to sell 150 equity shares at a Rs.1800 on or before 31-May-07. The person who sold the option is known as the option writer. A naked put option refers to a put option in which the option writer does not have a short position in the contract or underlying stock i.e. has not sold the contract without owning it.
In other words, if he has shortsold the contract he can square it off by buying back on or before expiry; Since he has not short sold the option contract he will get the premium paid to him in case the buyer chooses not to exercise the option. However, if the market price of Reliance remains below Rs.1800 on the expiry date the option holder may wish to exercise the option by purchasing Reliance shares from the market for, say, Rs.1750 and selling it to the option writer. The buyer gets a profit of Rs.50 per share.
On the last Thursday of April 2007 i.e. 26-Apr-07 the options contracts for the month of April expired and fresh series for the month of May were introduced. The market price of Reliance on 27-Apr-07 was Rs.1539. The Reliance Put Option premium for the 3 strike prices (above market price) traded are given below.
| Strike price | Premium |
| 1560 | 50.15 |
| 1590 | 68.55 |
| 1620 | 88.55 |
The premium paid is on close basis. The put option contract cannot be exercised without profits unless the market price falls below (strike price – premium) or 1509.85, 1521.45, 1531.45 respectively for the above contracts. Brokerage, commissions and other taxes are not included in this calculation and have to be considered separately for both options transactions and equity share purchases from the market.
During the month of May the market price of Reliance kept going up. The contract strike prices are fixed by the exchange in increments of Rs.30 for Reliance. 1650 strike price contracts began to trade from 03-May-07. As the market price of Reliance was increasing the premium amount of put option kept decreasing, since there was no way of exercising the option.
1800 strike price contracts began to trade from 22-May-07. The premiums for 1800 strike price contracts are given below.
| Date | Premium |
| 22-May-07 | 44.05 |
| 23-May-07 | 58.00 |
| 24-May-07 | 55.00 |
| 29-May-07 | 49.20 |
| 30-May-07 | 50.00 |
| 31-May-07 | 40.00 |
Let us assume that on 22-May-07 someone bought a put option by paying Rs.44 as premium. On 28-May-07 the market price of Reliance was 1724. So, he could buy from the market at this price and sell to the option writer at Rs.1800. His profits would work out to 1800 - 44 - 1724 = 32 per share or Rs.4800 for 1 lot of 150 shares. (Derivatives like futures and options are always traded in lots.)
The potential risk to the option writer in this case would be, strike price – premium or 1800 – 44 = 1756 for 1 share of Reliance or Rs.263,400 for 1 contract. If he is lucky enough he can sell the Reliance shares at a later date in the market for more than Rs.1800; otherwise he may have to sell for a lower rate and accept the loss.
On the contrary, a ‘covered put’ on Reliance would mean being short on the Reliance stock while selling a put option. The put option, when exercised, will force the option writer to buy Reliance from the option holder. Since the option writer is already short on the market, he can buy the stock from the option holder to square off his short positions, thus reducing his risk.