Equity shares aren’t the only instruments that you can invest in in the Indian share market. Another one of the most popular instruments is derivatives, more specifically, options contracts. When it comes to options, there are two different types that you need to be aware of - call options and put options. In this article, we’re going to take a look at what put option in the share market is and how they work. Let’s begin.
A put option is an instrument that gives the buyer of the option the right to sell an asset at a predetermined price to the seller of the contract. Here’s something that you should understand. Put options only give the holder (buyer) of the option the right, but not the obligation to sell. This effectively means that the holder of the put option can choose to exercise their right if they wish to or let the right expire.
Now that you know what a put option is, let’s take a look at how it works. We’ll do this with the help of an example.
Let’s say that you hold 500 shares in Reliance Industries, whose purchase price was Rs. 2,500 per share. Now, if the price of Reliance Industries were to fall below Rs. 2,500, you would incur a loss on your investment. And if the price increases beyond Rs. 2,500, you will make a profit.
Although you’re certain that the share price will increase in the future, you’re wary of the unpredictable nature of the stock market. Therefore, to protect your investment from the effect of a market downside, you wish to lock in the sale price.
To do this, you buy put option contracts of Reliance Industries for 500 shares at a strike price of Rs. 2,600. To purchase this put option contract, you pay a premium of Rs. 25,000 (500 shares x Rs. 50). This put option gives you the right to sell the 500 shares you own at the price of Rs. 2,600 to the seller of the put option contract.
On the date of expiry of the contract, as you feared, the share price of Reliance Industries dropped down to Rs. 2,400. Now, since you hold put options, you can enforce the contract and make the seller of the put option purchase your shares at the agreed-upon price of Rs. 2,600 instead of the current price of Rs. 2,400.
Despite the share price falling by about Rs. 100 from your original purchase price, you still managed to make a profit of Rs. 25,000 (Rs. 50,000 - Rs. 25,000) thanks to the put options that you bought.
But what if the share price of Reliance Industries rose to Rs. 2,700 instead of falling to Rs. 2,400 on the date of expiry of the put option contract? In that case, you can simply choose to let the option expire instead of exercising it.
Remember, the put option buyer (which is you) only gets the right and not the obligation to sell it at the agreed-upon price. So, you can simply let the contract expire and sell your shares in the open market for Rs. 2,700. The profit, in this case, would be Rs. 75,000 (Rs. 1,00,000 - Rs. 25,000).
With this, you must now be well versed with the concept of put option in the share market. To be able to trade in options contracts and other derivatives, holding a trading and Demat account is mandatory. Visit Motilal Oswal today to open a Demat account and a trading account within just a few minutes through a paperless process. Once you have the accounts open, you can proceed to trade in derivatives or invest in upcoming IPOs.
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