A contract governs the authority to sell securities. While stocks are frequently used as securities, other options include currencies and futures on commodities.
Since it is anticipated that you will strike when the stock price drops to that level or below, the price is known as the "strike price." It's only for sale until a specific date. That date is called the expiration date since it is when your decision expires.
If, prior to the expiration date, you sell your shares at the strike price, you have exercised your nifty put option under an American option.
How a Put Option Works?
Put options tend to gain value when the price of the underlying stock falls, making them valuable for hedging or betting on a downturn. A popular strategy involving put options is the protective put, which acts like insurance for investments. In this strategy, investors buy options to limit potential losses on a stock they own.
Also Read: Hedging Option Strategies
If the option is exercised, the investor sells the stock at the put's strike price. If the investor doesn't own the stock and exercises the put option, it results in a short position on the stock. This strategy helps manage risk by setting a maximum loss threshold for investors.
Benefits of Put Options
1. Earning Potential in Different Market Situations
The underlying asset or stock can experience any direction. Depending on social events, politics, and the economy, the value may change significantly. For an investor to benefit from a call option, the option must be bought below the strike price.
Put option buyers, on the other hand, may benefit if the asset's price remains unchanged or even declines. Put option traders profit more than call option traders.
2. Implied Volatility Advantage
Options implied volatility informs you about the cost. An option contract price often rises when implied volatility is high. A put option in share market trader wants to sell when the price is high and buy when it's low. This is conditioned to when the implied volatility is high but declines significantly.
It has long been a known fact that the implied volatility goes down with time; hence, traders who buy put options would benefit over time since the market’s natural condition is to their advantage.
3. Time Decay's Advantage
In the world of derivatives trading, timing is crucial for profit, and sellers have an advantage with time-bound options. An option contract's value decreases as it approaches its expiration date.
Put option sellers are, therefore, more likely to benefit from time decay if they sell their options while they are still valuable. Time decay, however, does not advantage those who own call options.
When to Sell a Put Option?
When you sell a put option in share market, you pledge to purchase stock at a predetermined price.
Sellers lose money if the stock price drops. This is the situation because they can only sell the stock at a lesser price, but they buy it at the strike price. They benefit if the stock price increases since the buyer will not exercise the option. The put sellers retain the fee.
Put sellers write a lot of options on companies they think will increase in value in order to keep their company afloat. They think that the fees they get will make up for the losses they incur when stock values drop.
Difference Between Put Option and Call Option
Aspect | Put Option | Call Option |
Definition | Gives the holder the right to sell | Gives the holder the right to buy |
Underlying | Typically associated with a decline in the price of the underlying asset | Typically associated with a rise in the price of the underlying asset |
Profit | Profits when the price of the underlying asset decreases below the strike price | Profits when the price of the underlying asset increases above the strike price |
Loss | Limited to the premium paid for the option | Limited to the premium paid for the option |
Breakeven Point | Strike price minus premium | Strike price plus premium |
Risk | Limited risk due to the defined loss | Limited risk due to the premium paid |
Time Decay | May benefit from time decay as expiration approaches | May suffer from time decay as expiration approaches |
The Bottom Line
Put options are a valuable tool for investors looking to manage risk and speculate on the market. They allow you to benefit from potential price declines while limiting your risk and providing insurance against losses. However, like any investment, it's important to do your research and fully understand the risks and benefits involved before making any decisions.
