Buying a Put
You have a view that the Australia 200 will decline sharply in the upcoming weeks. Based on this, you would like to place an option trade, risking no more than A$500.
In late October 2011, the Australia 200 is currently trading at 4450 and the December 4300 Put is priced at 44-50. You buy a put option at 50 in A$10/point.
The maximum risk, your premium, on this trade is A$500 [50 x A$10].
Upon expiry in December, if the Australia 200 is higher than 4300, you will lose the full premium of A$500, as the option will expire with no value.
If the Australia 200 expires in December below the strike price of 4300, it'll be worth A$10 for every point below 4300. To make a profit though, the Australia 200 will need to settle below your break-even level of 4250 [4300 - 50].
So if the Australia 200 expires at 4080, the option will settle with a value of 220 (the difference between the strike price and the settlement level). It will mean you've made 170 points on the trade as you've paid 50 for the option. The profit on your option will equate to A$1700.
Your profit/loss is:
170 (points gained) x A$10 (stake) = A$ 1700 (profit)
Selling a Call
You decide to sell a call as you have a bearish view on the market. This is very different from buying an option - the trade has no loss limit, and therefore greater risk is involved.
One of the advantages of selling an option though, is that it allows you to profit even if there is no significant move in either direction in the underlying market.
In mid August 2011, the Australia 200 is trading at 4300 and the Dec 4300 Call is priced at 212-218. You sell the option at 212 in A$10/point. Your maximum profit is the option price multiplied by the contract size, so in this case it would be $2,120. However, when selling options, your losses have no cap.
The maximum profit on this is:
212 x A$10 = A$2,120
Upon expiry in December, the Australia 200 is lower than 4300, the option will settle with no value and you receive the full profit of A$2,120.
If the Australia 200 expires in December above the strike price of 4300, the option will cost you A$10 for every point above 4300. Since you sold it at 212, the Australia 200 would need to settle below the break-even level of 4512 (4300 + 212), in order for you to make a profit.
Your break-even level is:
4300 + 212 = 4512
So, if the Australia 200 expires at 4550, the option will settle with a value of 250 (the difference between the strike price and the settlement level). Since you only received 212 for the option, you have lost 38 points, which equates to a loss of A$380.
Your profit/loss is:
38 (points lost) x A$10 (stake) = A$380 (loss)