Put Option

Posted in Finance, Accounting and Economics Terms, Total Reads: 588
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Definition: Put Option

Put Option in a stock market gives the holder the right to sell the underlying assets at the strike price (the specified sell price) at a predetermined date which is called the expiry date or maturity date( if its an American Put option then it cannot be sold before the specified date, but if its an European put option then it can be sold before that date).


If the strike price of an American Put option be K at a time t and the underlying assets be S(t), then the option holder can exercise the option at a value of k-S(t) until the expiry date. The put option will give a positive return if only the security price falls below the strike price. If the option is not exercised before the expiry then it becomes worthless.


For eg, B buys a put option to sell 100 shares of XYZ corp for Rs 50. B pays a premium of Rs 5. Now if the price of the stock falls to Rs 40 then B can exercise the option and buys 100 share for Rs 4000 from the stock market and sell them back in the market at Rs 5000. Thus the total profit that B makes is Rs500.


But if the price had not gone down below Rs 50 then B would not have exercised the option. In whole B would have lost Rs 500 (Rs 5 on per share basis on 100 shares)


Thus from the concept of Put option we see that it can be used as an insurance strategy. In this protective strategy the put owner purchases put option to cover the underlying asset so that in case if there is a drastic downwards slope of prices then he has an option to sell the put option at the strike price and not suffer loss. In the meanwhile a speculator can also use the same in a different use by taking a short position in the underlying stock without actually trading it.

 

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