Put Option in Share Market

Put option trading basics

In any market, there must be both buyers and sellers. Likewise, in the options market, call options are always accompanied by put options. Puts grants the holder the right to sell the underlying stock or index at a predetermined price on or before a specified future expiration date.

 

Despite being opposites, put options and call options share certain similarities. For instance, both types of options have predetermined strike prices and expiry dates set by the stock exchange.

How Do Put Options Function?

Understanding the mechanics of put options involves grasping several key terms:

• Strike Price: Agreed upon before the contract, it's the future price at which the put option can be exercised.

• Spot Price: The current market price of the underlying asset.

• Premium: Upfront fee paid by the buyer to the seller for the option.

• Expiration: The date when the put option expires, after which it cannot be exercised.

• Margins: Leverage used to purchase a put option, allowing for partial payment instead of the full contract price.

 

Put options are typically exercised by buyers when the spot price falls below the strike price, resulting in a profit equal to the difference between the two. However, once a put option reaches its expiration date, it becomes void, whether exercised or not.

While premiums represent a cost for buyers, margin trading is often used to mitigate initial capital requirements, allowing for more efficient use of funds.

When to Purchase Put Options?

Investors opt for buying put options when anticipating a decline in the stock market. This strategy is based on the premise that put options, granting the right to sell an underlying asset at a predetermined price within a specific period, tend to appreciate when the asset's price decreases.

 

Owning put options can prove profitable in a bearish market, serving both short speculators and investors seeking to hedge against potential losses. Whether holding stocks or speculating on market downturns, buying put options offers a viable avenue for potential gains.

When to Offload a Put Option?

Selling a put option entails committing to purchase a stock at a predetermined price. It's advisable to sell put options only if comfortable acquiring the underlying security at the agreed price, as this entails an obligation to buy if the counterparty chooses to exercise it.

If the stock price declines, sellers incur losses as they must buy the stock at the strike price, but can only sell it at a lower price. Conversely, if the stock price rises, sellers profit as the buyer is less likely to exercise the option.

Put sellers generate revenue from fees. They sustain their operations by writing numerous options on companies they anticipate will appreciate. In the event of stock price declines, they rely on the fees received to offset potential losses.

Advantages of Put Options:

• Put options offer profit opportunities regardless of market direction, allowing traders to capitalize on various scenarios.

• Put option sellers benefit from time decay as options lose value over time, maximizing profits when selling options.

• High implied volatility leads to higher option prices, providing opportunities for option sellers to capitalize on inflated premiums.

• Put option buyers can profit as implied volatility tends to decline over time, aligning market conditions in their favor.

Illustration Of A Put Stock Option

Put options function similarly to call options but reflect a bearish outlook on the stock's price. For instance, if you own ABC shares and anticipate a drop from Rs 950 per share, you might buy a put option with a Rs 930 strike price at a Rs 10 per share premium. If ABC's price falls to Rs 930, you may consider exercising the option, earning a profit of Rs 10 per share after deducting the premium. Conversely, if the price rises, your loss is limited to the premium paid.

Frequently Asked Questions

1. What is a put in the stock market?

In the context of shares, a "put" refers to a put option contract. This contract grants the buyer the right, though not the obligation, to sell or sell short a predetermined quantity of an underlying security at a predetermined price within a specified timeframe.

 

2. What is an example of a put option?

Let's say XYZ stock is trading at Rs. 50 per share. Put options with a strike price of Rs. 50 are available for a premium of Rs. 5 and have a six-month expiration period. Purchasing one put contract, covering 100 shares, would cost Rs. 500 (Rs. 5 premium x 100 shares). The graph below illustrates the profit or payoff for the put buyer at various stock prices.

 

3. What occurs when you purchase a put?

When you buy a put option, you acquire a contract granting you the right to sell a specified number of equity shares at the strike price before the option's expiration. If the stock price declines below the strike price, investors exercise the option if they own shares of the stock.

 

4. What constitutes the profit of a put option?

The profit of a put option arises when the stock price descends below the strike price before expiry. The precise profit amount hinges on the variance between the stock price and the option strike price at either expiration or when the option position is terminated.

 

5. How can I generate monthly income by selling put options?

A strategic approach involves selling one or more cash-secured put options, assuming the responsibility to potentially purchase shares at a predetermined price before a specified date, and receiving upfront payment for assuming this obligation. Essentially, you commit to buying the stock if it declines, aligning with your original intention, while earning income in the process.