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What is a put option contract?
Put option is the contract in which the holder has a right to sell equity shares of number at strike price before an expiry date.
Put option is available in stocks, indexes, commodities and currencies.
Price change is impacted by underlying assets, time decay, interest rates, and strike price. If there is decline in interest rate and increase in underlying asset, then value of put option increases.
If there is decrease in interest rates, underlying assets and nearing expiry dates, then value of put option decreases.
If the option expires is profitable then, it will exercise and if option expiry is unprofitable, then the money paid option is lost.
Key features
The key features of put option contract are given below −
| Specifics | Premium | Margin | Kinds | Sellers premium |
|---|---|---|---|---|
| Strike price is fixed | Option premium is paid to broker | Initial margin | Stock call | Amount paid through brokers and exchange |
| Expiry date is chosen | Broker transfers the premium to exchange | Exposure margin | Index call | Reduces loss |
| Option price can be selected | Exchange sends amount to seller (option) | Premium margin | Increase profits |
Advantage − Investors have a chance to speculate on securities.
Disadvantage − Huge loss, if the expected price is not reached.
Types of put option contract
- American − Stock options (more flexible and trade can be settled before expiry of contract date).
- European − Index option (exercised only on date of expiry).
Example
Mr. A buys 1000 shares of Apt ltd through brokerage.
Some estimated share price will fall in the next three months from the present rate (Rs.150/-). By opting a put option, Mr. A can sell his shares at strike price (Rs.150/-) even after 3 months. He can still sell his securities, if price falls below strike price (Rs.150/-)
Let assume investor wants exercise his option when stock price is below strike price (let say current stock price is Rs.100/- and premium charges of Rs.5/- per share)
Total earnings ⇒ 50 * 1000 ⇒ 50000/-
Premium charges ⇒ 5 * 1000 ⇒ 5000/-
Net earnings ⇒ total earnings – premium charges ⇒ 50000 – 5000 ⇒ Rs.45000/-
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