A put option is an option contract giving the owner the right, but not the obligation, to sell a specified amount of an underlying security at a specified price within a specified time. This is exactly opposite of call option.
Options are derivative contracts having a strike price and expiry. For example we have nifty options contracts with various strikes and expiry. The number of shares of Nifty options are 75 as on 15th Sep 2016. NSE periodically revises the contract size.
In the previous post we have learned the call option. The only difference is that when someone buys put option he bets the market will go down. When someone sells a put option he bets the market will either go up or stay above the strike price till expiry.
Notice one thing, whatever the buyer of the option anticipates, the seller anticipates the exact opposite, therefore a market exists. I presume that you have the basic knowledge options. If you want to learn the basics, please refer my blog “Option Greeks“.
You can have a look at at NSEindia.com web site by clicking on the above link . You can check the live price of nifty PE contracts here. Nifty index is the underlying asset for these contract.
As a trader you can either buy or sell a put option. Before jumping in ,you need to understand when to buy a put option and when to sell.
Buy a put option
When you are buying a put option you are betting that the price of the Stock or Index will move down. You will pay the premium for the contract and your account will be debited with the price of option multiplied with number of units.
When you buy Nifty Oct 8500 PE on 29th Sep 2016, you will pay a total premium of Rs. 6975 (93 x 75). You will gain if the market moves in your direction. As and when the nifty starts moving downwards the option price will rise. You can sell the option contract at any time before the expiry period and collect the difference in premium.
Today 30th Sep 2016 nifty crashed 153.9 point on India – Pak war fear. Yesterday, if you had purchase one lot of 8500 PE, today you would have earned (20-106.25) x 75 = Rs. 7968.75 for one contract of Nifty.
So your net profit for one lot nifty for just one day is Sell price minus buy price – 7968.75 – 6975 = 993.75. But this type of opportunity is very rare in market.
Sell a put option
While selling a put option you are betting that the market will not go down. You are moderately bullish or even neutral. If nifty stays above your selected strike price you will pocket the premium.
Naked option writing (selling) is very dangerous in volatile market. Let’s take the above example. If you have sold out one lot Nifty Oct 8500 PE, today your loss will be 993.75. You still have one advantage that you have one more moth ahead.
If nifty stays above 8500 , the premium will gradually reduce to zero. But if Nifty closes below 8500 you will incur loss. In order to avoid such huge losses you can try other safer strategies like iron condor or short strangle where one leg will compensate for the loss in other leg.
Hope this article helped you in understanding options. Kindly post your comments and suggestions. Happy reading…