• Types of Options – 2

    Buy Put Option

    Put options buyers get the right to sell an underlying index or security at a particular price (same as strike or exercise price) on a particular date (expiry date). The put writer has to buy the asset at that price if the put buyer exercises the option. As the put buyer owns the rights, there is no credit risk involved and he pays only the premium to buy the right.

    Buying put options are used to take Short positions in the market as it bets for price decrease in the short term future.

    • If the trader believes that the market index will definitely decrease in the short term he will buy put options.
    • Suppose on 10th July 2011, Nifty is currently trading at 5600 and put premium of one Nifty put option with strike price 5500 and expiry date as 28th July 2011 is trading at Rs 50. Here the trader wants to take short position will buy the option at Rs 50 with the anticipation of downward movement in the Nifty index.
    • The premium will be traded based on the Nifty index and will increase if nifty index goes down and will decrease if nifty index goes up.
    • The final premium value at the end of expiry period will be decided based on the nifty index value at that time.
      • If at the end of expiry date Nifty index < Strike Price; Then the premium will be the difference between Nifty index and Strike Price (Premium = Strike Price – Nifty index).
      • If at the end of expiry date Nifty index >= Strike Price; Then the premium will be zero irrespective of the Nifty Index.
      • Most of the cases, the traders do not prefer to wait for expiry. They sell the premium at higher prices just like normal shares with the downward movement of nifty to book profits.

    Sell or Write Put Options

    Put options seller are obliged to buy an underlying index or security at a particular price (same as strike or exercise price) on a particular date (expiry date) if the put buyer exercises the option. The put writer has no other choice except to buy the asset at that price if the put buyer exercises the option. As the put writer is obliged to buy if the seller uses his right, there is significant credit risk involved and he has to pay huge margin amount to sell the put option premium.

    Selling put options are used to take long positions in the market as it bets for price increase or stable range bound price in the short term future.

    • If the trader believes that the market index will either increase or stay range bound in a short range in the short term he will sell put options.
    • Suppose on 10th July 2011, Nifty is currently trading at 5600 and call premium of one Nifty put option with strike price 5500 and expiry date as 28th July 2011 is trading at Rs 50. Here the trader wants to bet on increase or stable position will sell the option at Rs 50 with the anticipation of upward or range-bound movement in the Nifty index.
    • The premium will be traded based on the Nifty index and will increase if nifty index goes down and will decrease if nifty index goes up or stays above 5500.
    • The final premium value at the end of expiry period will be decided based on the nifty index value at that time.
      • If at the end of expiry date Nifty index < Strike Price; Then the premium will be the difference between Nifty index and Strike Price (Premium = Strike Price – Nifty index).
      • In this case, put writer’s profit will be the difference between Rs 50 and the end premium.
      • If at the end of expiry date Nifty index >= Strike Price; Then the premium will be zero irrespective of the Nifty Index.
      • In this case, put writer’s profit will be the initial premium or Rs 50.
      • Put writer will gain if the Nifty closes above 5450 at the time of expiry.
      • Most of the cases, the traders do not prefer to wait for expiry. As the expiry date comes close and the nifty stays above 5500, the premium decreases with time.
      • They square off the premium at lower prices just like normal shares with the favorable movement of nifty to book profits. It is similar as short selling.

     

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