Q:
Please explain, What are Put Options? Also give an simple example?
A:
A Put option gives the holder (buyer / one who is long 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 Put) however, has the obligation to buy the underlying asset at the strike price if the buyer decides to exercise his / her option to sell.
Example:
An trader buys one European Put option on Stock 'BB' at the strike price of Rs. 400, at a premium of Rs. 30. If the market price of Stock 'BB', on the day of expiry is less than Rs. 400, the option can be exercised as it is 'in the money'.
The trader's Break-even point is Rs. 370 (Strike Price - premium paid) i.e., investor will earn profits if the market falls below Rs. 370. Suppose stock price is Rs. 360, the buyer of the Put option immediately buys Stock 'BB' from the market at Rs. 360 and exercises his / her option selling the Stock 'BB' at Rs. 400 to the option writer thus making a net profit of Rs. 10 {(Strike price - Spot Price) - Premium paid}.
In another scenario:
If at the time of expiry, market price of Stock 'BB' is Rs 420; 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 trader loses the premium paid (i.e. Rs.30), which shall be the profit earned by the seller of the Put option.
No comments:
Post a Comment