NATIONAL UNIVERSITY OF SCIENCE AND TECHNOLOGY

FACULTY OF THE BUILT ENVIRONMENT

DEPARTMENT OF QUANTITY SURVEYING

CONSTRUCTION FINANCE BQS4203

ICEMAN MAHOHOMA N02021649E

BRILLIANT MASHINGAIDZE

MELLUSI CHIKURA

SHYLEEN NYONI
Introduction

The issue of derivative markets constitutes transactions such as stock, bond trades and
they can be the long and the short sides and the short side is analogous to the seller
and this sides benefits when the price falls (Federal Reserve Bank of Chicago, 2013).
These derivatives do not include a change of ownership on the underlying right or
interest when a transaction is made (Pradhan et al, 2014). So in the context of put
options it is a contact that gives the owner the right to sell a fixed amount of a specified
asset at a given or fixed price within the given timeframe which is on or before the fixed
date (Vo et al, 2019). Sendeniz-Yuncu et al (2018) highlights that in a country with well-
functioning derivatives markets it is easy for firms to share risks as well as conduct high
risk projects so as to enjoy an economic growth.

Definition of key terms

Derivative

This is a product whose value is taken from the value of one or more basic variables
called bases or in other words underlying asset, index or reference rate which is done in
a contractual manner (Joshi, 2019).

Derivative market

This is a platform where traders buy and sell contracts that derive their value from
underlying assets for instance interest rates, commodities and stocks (Chui, 2014).

Put

This is a contract that gives a buyer the right but not the obligation to sell an underling
asset at a specified price called a strike price before or on the expiry date (Joshi, 2019).

Short put

This strategy involves writing or selling a put option on an underlying asset (Joshi,
2019).
A short put is a type of option strategy where the seller (writer) of a put option receives a
premium for giving the buyer the right to sell the underlying asset at a specified price
(strike price) before the option expires (Vo et al, 2019). The seller of a short put hopes
that the price of the underlying asset will stay above the strike price, so that the option
will expire worthless and the seller can keep the premium as profit (Joshi, 2019). A short
put can be either covered or naked. Furthermore Pradhan et al (2014) mentions that
covered short put means that the seller has enough cash or margin to buy the
underlying asset if the option is exercised. A naked short put means that the seller does
not have enough cash or margin, and may face a large loss if the option is exercised
and the underlying asset's price falls below the strike price (Ruiz and Jose, 2018).

Short put strategy is directional and bullish. It is generally profitable when the underlying
price goes up (or doesn't go down at least and this is referred to as a short volatility
strategy, as the value of a put option declines when volatility decreases, which means
your short put position becomes more profitable Huang et al, 2017). In other words,
when selling a put option, you want the underlying security to not go down, or not move
at all (assuming you've sold an out of the money put) (Khan, 2017). You want the
underlying price to end up above the strike price, so the put option expires worthless
and you keep the entire premium (Coskun, 2017). Short put strategy has limited upside,
equal to the cash you get when selling the put option in the beginning which is generally
the maximum you can gain from the trade (Atilgan, 2016). It has limited risk (unlike a
short call trade whose risk is unlimited), equal to the strike price less the initial option
price. However, in most cases the option price is much lower than the strike price, which
means the maximum possible loss is typically much higher than the potential profit
(Huang et al, 2017).

Maximum profit

Maximum profit is reached when the underlying security ends up at or above the put
option's strike price and the option expires worthless. Below the strike price your profit
declines in proportion with the underlying price (Zhou, 2016).
The maximum you can gain from a short put trade is the amount you receive at the
beginning when selling the put. If the option expires worthless, there is no more cash
flow from the trade and you keep all the initial cash, which is also your total profit. For
this to happen, the underlying security must end up at or above the put option's strike
price at expiration.

Short put payoff formulas

Short put payoff per share = initial option price – option value at expiration

Put option value at expiration = MAX(0, strike price – underlying price)

Short put payoff per share = initial option price – MAX(0, strike price – underlying
price)

Short put payoff = (initial option price – MAX(0, strike price – underlying price)) x
number of contracts x contract multiplier

Break-Even Point

The break-even point of a short put position is exactly the same as long put break-
even.

Short put B/E = strike price – initial option price

Using the information from the insert, strike price is $45 and initial option price is $2.85,
which makes the break-even equal to

45 – 2.85 = $42.15

This particular short put trade is profitable if the underlying ends up above 42.15; if ends
up below this price, the trade will be a loss. You can also see it in the chart, where the
P/L line crosses the zero line at 42.15.

Here is a mathematical example of a short put:

Suppose you sell a put option on XYZ stock with a strike price of $50 and an expiration
date of March 31, 2024. You receive a premium of $3 per share for selling the option.
The option contract covers 100 shares, so your total premium is $300.

There are two possible scenarios at expiration:

- Scenario 1: XYZ stock is trading above $50 on March 31, 2024. The put option expires
worthless, and you keep the $300 premium as profit. Your return on investment is
$300 / $0 = infinity.

- Scenario 2: XYZ stock is trading below $50 on March 31, 2024. The put option is
exercised, and you are obligated to buy 100 shares of XYZ stock at $50 per share, for a
total cost of $5,000. Your net loss is $5,000 - $300 = $4,700. Your return on investment
is -$4,700 / $0 = negative infinity.
In conclusion a short put has a limited profit potential and a potentially unlimited loss
potential. Therefore, it is a risky strategy that requires careful risk management and
analysis of the underlying asset's price movements.
References

1. Chui. M. (2014). Derivatives markets, products and participants: an overview.

2. Joshi. M. C. (2019). Derivative market.
3. Pradhan. R. P, Mak. B. A, Hall. J. H & Bahmani. S. (2014). Causal Nexus
Between Economic Growth, Banking Sector Development, Stock Market
Development and Other Macroeconomic Variables: The case of ASEAN
Countries.
4. Ruiz. J. L. (2018). Financial Development Institutional Investors and Economic
Growth. International Review of Economics and Finance.
5. Sendeniz-Yuncu, IIIka, Levent & Aydogan. (2018). Do Stock Index Futures Affect
Economic Growth? Evidence from 32 countries
6. Vo. D. H, Huynh. S. V, Vo. A. T & Ha. D. T, (2019). The importance of the
Financial Derivatives Markets to Economic Development in the World’s Four
Major Economies.
7. Coskun. Y, Unal. S. H, Murat. Ertgrul & Talat. U. (2017). Capital Market and
Economic Growth Nexus: Evidence from Turkey.
8. Huang. P.M. Kabir. K & Zhang. Y. (2017). Does corporate Derivative Use
Reduce Stock Price Exposure? Evidence from UK Firms.
9. Khan. H,.H, Ali. M, Naz. I& Qureshi. F. (2017). Efficiency, Growth, and Market
Power in the Banking Industry.
10. Vo. D. H, Nguyen. P. V. Nguyen. H. M, Vo. A. T & Nguyen. T. C. (2019).
Derivatives Market and Economic Growth Nexus.
11. Zhou. T. (2016). Overview on Derivatives Trade in China.