Introduction to Put-Of-More Options:
Put-Of-More (POM) options, also known as put-of-the-money options, are a type of financial derivative that gives the holder the right, but not the obligation, to sell an underlying asset at a strike price lower than the current market price. These options are less commonly traded compared to traditional put options but can serve as valuable tools for investors seeking alternative strategies in the financial markets. Let’s delve into the concept of Put-Of-More options, their characteristics, and how they differ from traditional put options.
Key Points about Put-Of-More Options:
- Definition: Put-Of-More options are a variation of standard put options, providing the holder with the right to sell an underlying asset at a strike price lower than its current market price. Unlike traditional put options, which have a strike price higher than the market price (out-of-the-money), POM options have a strike price below the market price.
- How Put-Of-More Options Work:
- The holder of a Put-Of-More option pays a premium to the seller for the right to sell the underlying asset at a predetermined strike price.
- If the market price of the underlying asset falls below the strike price before the option expires, the holder can exercise the option and sell the asset at the higher strike price, realizing a profit.
- However, if the market price remains above the strike price at expiration, the option expires worthless, and the holder loses the premium paid.
- Characteristics of Put-Of-More Options:
- Strike Price: The strike price of a Put-Of-More option is lower than the current market price of the underlying asset.
- Expiration Date: Like traditional options, POM options have an expiration date, after which they become invalid.
- Premium: The premium paid for a Put-Of-More option is determined by various factors, including the volatility of the underlying asset and the time to expiration.
- Example of Put-Of-More Option:
- Suppose an investor believes that the price of Company XYZ’s stock, currently trading at $60 per share, will decline in the near future due to negative market sentiment. The investor purchases a Put-Of-More option with a strike price of $55 and an expiration date of one month, paying a premium of $3 per share.
- If the price of Company XYZ’s stock falls to $50 per share before the option expires, the investor can exercise the option and sell the shares at the higher strike price of $55, realizing a profit of $2 per share ($55 – $50 – $3 premium).
- However, if the stock price remains above $55 at expiration, the option expires worthless, and the investor loses the premium paid.
- Differences from Traditional Put Options:
- Strike Price Position: Unlike traditional put options, which have a strike price above the market price (out-of-the-money), Put-Of-More options have a strike price below the market price (in-the-money).
- Profit Potential: Put-Of-More options offer the potential for higher profits compared to traditional put options if the market price falls significantly below the strike price.
- Uses of Put-Of-More Options:
- Speculation: Traders and investors may use Put-Of-More options to speculate on potential downward movements in the prices of underlying assets, particularly when they anticipate substantial declines.
- Risk Management: Put-Of-More options can also be used as part of a risk management strategy to hedge against downside risk in investment portfolios.
Understanding Put-Of-More options and their characteristics is important for investors looking to diversify their options trading strategies and manage risk effectively in the financial markets.
Reference: Hull, J. C. (2017). Options, Futures, and Other Derivatives. Pearson Education.