InvestorQ : How exactly do put options work in the stock markets?
Bhavik Nehru made post

How exactly do put options work in the stock markets?

Answer
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Bhavik Nehru answered.
2 years ago


A Put option gives the holder (buyer/ one who is long on the put), the right to sell specified quantity of the underlying asset at the strike price on or before an expiry date in case of American option. The seller of the put option (one who is short on put) however, has the obligation to buy the underlying asset at the strike price if the buyer decides to exercise his option to sell. Let us look at an illustration of a put option and how it will work for Tata Steel 550 call option. Let us say that an investor buys one European Put option on Tata Steel at the strike price of Rs. 550, at a premium of Rs. 15. If the market price of Tata Steel, on the day of expiry is less than Rs. 550, the option can be exercised as it is 'in the money'. The investor's Break-even point is Rs. 535 (Strike Price - premium paid) i.e., investor will earn profits if the market falls below 535. Now, let us suppose that the stock price is Rs. 510, the buyer of the Put option immediately buys Tata Steel from the market @ Rs.510 & exercises his option selling the stock of Tata Steel at Rs 550 to the option writer thus making a net profit of Rs. 25 {(Strike price - Spot Price) - Premium paid}. What if the price of Tata Steel goes the other way? In another scenario, if at the time of expiry, market price of Tata Steel is Rs 580; the buyer of the Put option will choose not to exercise his option to sell as he can sell in the market at a higher rate. In this case the investor loses the premium paid (i.e. Rs 15), which shall be the profit earned by the seller of the Put option. Such options are known to expire worthless and the maximum loss in such cases is the total premium paid.

CALL OPTIONS)

PUT OPTIONS

Option buyer or option holder

Buys the right to buy the underlying asset at the specified price

Buys the right to sell underlying asset at the specified price

Option seller or option writer

Has the obligation to sell the underlying asset (to the option holder) at the specified price.

Has the obligation to buy the underlying asset (from the option holder) at the specified price