TeachMeFinance.com - explain Privilege
Privilege -- A general name for a call, put, spread or straddle,
information as to each of which is furnished under its own
There can be no loss to the buyer of a privilege beyond the
amount paid for it. Privileges are legal and are enforceable as
contracts, but they are not recognized by the New York Stock
Privileges are often bought as a protection against loss on
transactions in the stock market. Illustration : One hundred
shares of stock are bought at 100. A put under which the
stock can be delivered at 98 is purchased for 1 per cent, which
makes the net price of the put 97. Then, if the stock goes
down to, say, 94 the stock owned by the holder of the put can
be put (delivered) to the issuer of the put at 98 so that the
net loss is only 3 per cent instead of 6 per cent as would be the
case if no put had been bought and the stock had to be sold at
94. On the other hand, should the stock go up to, say, 106 only
the cost of the put, 1 per cent, would have to be deducted
from the profit on the stock.
In the case of a stock sold short a call would be employed
for protection against loss. If the stock were sold short at
loo and if a call at 102 were purchased for 1 per cent and the
stock advanced to 106 the net loss would be only 3 per cent,
as against 6 per cent if no call had been purchased and the
stock had to be covered (bought back) at 106. If the stocK
against which the put was bought went down to 94 only a deduction
of 1 per cent, the cost of the put, would have to be
made from the profit on the stock.
Calls and puts on grain are based on the same general principles
as those on stocks , but they are not employed to any
extent except to limit loss. In some states puts and calls on
grain are illegal.
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