OPTIONS TRADING:PUT OPTIONS

PUT OPTIONS

Put Option is an option where buyer gets the right to sell the Underlying but not any obligation. Buyer of the Put option expects the price to go down. The Maximum loss to the buyer of the Option is limited up to premium paid. If prices falls than Put buyer earns unlimited profit. Let us look at one example to make it clear.

Example:

For Put Buyer

Mr. Y has purchased the Nifty 24 June2010, 5100 Put Option at Rs.100.
Here, Underlying is Nifty. || Strike Price is 5100. || Option is Put Option (Right to Sell). || Maturity (Expiry) is 24 June 2010. || Premium is Rs.100.

So when spot price falls below 5100, Mr. Y will exercise his right to sell Nifty at 5100. So he will get benefit when market falls below 5100. So if Market falls to 4900 he will get Rs.200 back but as he has paid Rs. 100 as premium so his net profit would be Rs.100.

Payoff for Put buyer

Spot Price Pay-off
4600 400
4700 300
4800 200
4900 100
5000 0
5100 -100
5200 -100
5300 -100
5400 -100
5500 -100

For Put Seller

Now suppose Mr. Y has sold the above option. Now his maximum profit is up to premium he received and his loss is unlimited. Now when market moves the payoff of seller is as follows:

Payoff for Put Seller

Spot Price Pay-off
4600 -400
4700 -300
4800 -200
4900 -100
5000 0
5100 100
5200 100
5300 100
5400 100
5500 100

Break Even Point (BEP) for Put Option

BEP is a point when Options seller and buyer arrive at no profit and no loss situation. It is the price where trader is neither earning nor losing any money. Here, both buyer and seller remain at cost to cost.

For Put option BEP = Strike price - premium.

In above both example, 5100 - 100 = 5000. (Strike - Premium)
That means, when spot reaches 5000, Mr. Y neither earns nor loses any money.