How put option works in derivative market
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In the option market call option have no existence without put option. Put option enable you to sell the underlying index or stock at a predetermined price in future on or before a particular expiry date. Call option and Put option are opposite to each other. But they have some similar characteristics also. The expiry date and strike price of put option is also predetermined by the stock exchange.
Unlike call option a put option helps you to fix the selling price. If you expect a possible decline in the future for an underlying asset then you can fix selling price for your put option. To avoid losses pay a simple premium amount. We use put option under bearish market conditions. American put option and European put option are the two different kinds of put options. American option allows you to settle the trade before expiry of the contract. It is more flexible than European option. For example stock option. Rather than American option European option can only be exercised on the expiry date of the contract. For example index options.
Put Index option
To maximize your profit the simple rule that you need to follow is buy at low price and sell at high price. First consider put index option trade. Suppose the current market price of Nifty is 6000 and with the expectation that its price will decline future you decided to purchase it at the strike price of 5900. So your premium amount is 1000. That is 10 for each unit and a total of 100 units thus the total premium amount of 1000. If the Index price rises above the current market price you don’t get any benefit from it. And you lose your premium amount also. But if Nifty price decreases and it reaches 5800 then also you are not in profit. This is because of your premium amount. You will start making profit only when the price decreases below 5800.
Put stock option
Call stock option and put stock option are work in the similar way. The difference is buyer of put stock option hopes to make profit from a fall in price. Their expectation about the market is bearish. Suppose you fetch quarterly result of a specified stock and identified that it is likely to underperform analyst forecasts. If there is a chance for fall in the share price from the current share price of 950 then you can buy that stock. In order to make profit from fall in price, buy the stock at a strike price of Rs 930 and pay a premium of Rs 10 per share. Suppose your contract contains 600 shares. This means your premium amount is 6000. Remember, you can exercise your stock position before expiry date. So carefully monitor your stock movement and gains back right before expiry. The stock price may fall beyond your expectation but don’t be greed if you have got enough profit don’t wait further then clear out your position. Don’t miss the chance to make profit. That is if stock falls to 930 you could exercise your position. But you will not get any profit at this position because of your premium amount. For this reason you could wait to fall the price to at least Rs 920. If there any chance to fall the price below 920 you can wait otherwise exit from your position.
However the reverse may also happen. Beyond your expectation if the price rise rather than fall then ignore that option. But you lose your premium amount of Rs 6000.
The initial payment/margin required for buying or selling put option
A buyer as well as a seller has to pay an initial margin and exposure margin. In addition to these additional margins are collected. And it is different for buyers and sellers.
A buyer of put options has limited liability. Buyers and sellers are at the opposite ends of the spectrum. Both of them have to pay an initial as well as exposure margin. A seller is also known as writer. Theoretically prices can rise to any heights; so that a put option writer has to buy at whatever price he has been specified. So the potential loss of a seller is unlimited.
Seller of a put option has to deposit assignment margin with the exchange as a security in case of an adverse movement in the price of the options sold. Just like the call option the margin amount is levied on the put contract value and is and is calculated in percentage terms. During higher volatility time margin requirement typically rise. The assignment margin of a seller is dictated by the exchange.
For example, The margin amount to be deposit by a put option seller is Rs 1,16,400 against the total value of his outstanding position of Rs 5,82,000 whose put option strike price is Rs 970 with 20% margin requirement, and who receives a premium of Rs 10 per share,
Settlement of put option
You can settle your put option in any of the following method. Squaring off, physical settlement, and selling. In squaring off method you can purchase a contract to buy the very same stock if you hold a contract to sell the stock. By doing this you will get the difference in prices and premiums as your profit. The next is physical settlement, in this before the expiry date of your contract you will actually sell the underlying stocks as specified in the option contract agreement. Third one is the selling method. In this method you can simply sell your put option that you hold.
If you are a buyer of a put option then in order to square off your position you need to buy the same number of call option of the same underlying stock and maturity date. By doing this you will get premium amount on the contract as a seller. So the difference between premium amounts will be your profit or loss. However, your maximum loss of a seller will be restricted to the premium paid. Similarly sellers to square off their position they will have to buy back the same number of put options that they have written with the identical underlying asset and maturity date. Here the stock exchange will calculate the profit/loss on your position. Your losses will be adjusted against the margin that you have provided to the exchange.
call and put are the two options of derivative market. In the previous blog call option was explained. Here are some details of major financial market.