What is Put Option: Meaning, Benefits, and How it Work in Stock Market
18 January, 2025
Synopsis
Put Options may provide insurance against falling prices.
They help protect investments and profits.
Put Options are a key part of the derivatives market.
In financial markets, Put Options are popular for providing insurance against falling prices. They are essential in the derivatives market, helping traders and investors to protect your investments and profit from market movements. This article explains the meaning of Put Options, their features, benefits, and operation within the financial landscape.
What is a Put Option?
A Put Option is a financial agreement granting the holder the right, but does not obligate them, to sell a certain amount of a primary asset at a prearranged price (known as the strike price) within a set time frame. This asset could be Stocks, Indices, Commodities, or Currencies. The person selling the Put Option, also known as the writer, must purchase the asset at the strike price if the holder decides to exercise the Option.
Features of Put Options
The following are key features of Put Options:
Right to Sell: As a holder you can sell the underlying asset at the strike price, benefiting when the asset's price falls below this level.
Strike Price: This predetermined price is crucial for determining the Option's profitability.
Expiration Date: Options expire on a set date, typically the last Thursday of each month in India.
Premium: Buyers pay a premium to sellers, which varies based on asset volatility, time to expiration, and current versus strike price.
How Put Options Work
To understand how Put Options work, consider an example involving a stock trading at ₹500. Suppose you buy a Put Option with a strike price of ₹480, expiring in one month, for a premium of ₹10. Here is how different scenarios might play out:
Stock Price Falls Below Strike Price: If the stock price drops to ₹450, you can exercise the Put Option to sell the stock at ₹480. The profit from this transaction would be the difference between the strike price and the current price, minus the premium paid: (₹480 - ₹450 - ₹10) = ₹20 per share.
Stock Price Remains Above Strike Price: If the stock price remains above ₹480, the Put Option expires worthless, and you lose the premium paid (₹10 per share). However, this loss is limited to the premium amount.
Stock Price Equals Strike Price: If the stock price equals the strike price of ₹480, you break even, considering the premium paid, however you will lose the premium paid of ₹10.
Benefits of Put Options
The following are benefits of investing in Put Options:
Hedging: Protect portfolios from potential losses by offsetting declines in asset value.
Leverage: Control larger positions with a small investment, potentially yielding significant gains.
Income Generation: Generate immediate income by selling Put Options and collecting premiums, though this obligates buying the asset if exercised.
Flexibility: Provide versatile trading strategies, allowing for speculation, hedging, and complex strategies like spreads and combinations.
Trading Put Options
The process of trading Put Options involves:
To trade Options, you need to open a trading account with a registered broker.
Option chains display all available Options for a particular underlying asset, including the strike prices, premiums, and expiration dates. You can use Option chains to analyse and select the appropriate Put Options.
You can place orders to buy or sell Put Options through your broker’s trading platform. It is essential to specify the strike price, expiration date, and quantity of contracts.
Once the trade is executed, you need to monitor your positions and manage them based on market movements and your trading strategy.
Open a Demat Account with HDFC Securities
Put Options offer you tools to hedge against losses, speculate on market declines, and generate income. Understanding their workings and features is essential for effective trading. Using an HDFC Securities Demat account simplifies trading, providing a secure and efficient platform to incorporate Put Options into investment strategies and achieve financial goals.
Open a Demat Account + Trading Account all at once with HDFC Securities. Open today!
*Disclaimer: Terms and conditions apply. This article is only for educational/ informational purpose. It does not make any recommendation to act or invest. Investments in securities market are subject to market risks, read all the related documents carefully before investing. or invest
