Clarifying ‘Put Options’, What You Need To Know? | srei

Clarifying ‘Put Options’, What You Need To Know?

Apart from mutual funds, stocks and bonds, there is another kind of investment, called options, which offer a gamut of opportunities to seasoned investors. The best thing about options is that you can make money even when the stock prices are going down. Options are versatile investment tools that can be used to micromanage an investor’s portfolio. There are two types of options – Put and Call. A put option is the right to sell a stock at a specific price before a certain date. A call option gives the investor the right to buy on the stock at a strike price. (The price at which a put or call option can be purchased or sold). Remembering it easily, a put option is the exact opposite of a call option.

To understand put options better, let’s take a simple example. Say your home is currently valued at rupees 60 lakhs and the company you work for requires you to relocate in the coming six months. You are now planning to sell your home after six months. When you approach a potential investor, you mention that you are planning to sell your house for its current value (60 lakhs) but with an option to sell it within the next six months with an additional fee. We will now look at two different scenarios once the investor decides to buy your house, with this additional stipulation. Let us assume that a few months down the road the property value in your area skyrockets and your house is now valued at 70 lakhs. In this case it is better to sell your home in the open market letting the contract with your investor expire. This decision will cost you the premium that you have paid but you still end up making a profit. In the other scenario, there is a decline in property value in your area. In this case you should exercise the right to sell your home to the investor according to the contract. In spite of the additional fees paid as premium, you still make a profit as you end up with an amount much larger than the current market price. 

Put options in the world of stock markets work in a similar manner and offer you the option to sell stocks at a stipulated price. Let’s say that there is a stock trading at 100 rupees per share and you expect its value to fall to 90 rupees in the coming weeks. In this case you can buy a put option contract to sell the stock at 100 rupees per share between now and a stipulated time. Investors have the option to buy more time at an additional cost. Now investors have the option to sell these stocks at 100 rupees and buy back the same shares at 90 rupees. The investor makes an 8 rupee profit on each stock or an 800 rupee profit per contract after you minus the 2 rupee premium paid. Each options contract consists of 100 shares. This means that the investor makes a 400% return when the share prices fall by 25%. The risk involved is a 200 rupee loss of premium, if the share prices go up and the investor allows the options contract to expire unlike shorting a stock. However, the amount that is required to be put up is limited with limited liabilities.

Put options are an excellent way to protect you against losses, particularly when dealing with market volatility.