We had introduced the meaning of a Call option in an earlier post. (Click here to read part I.)
In this post we introduce the concept of a Put option.
In this post we introduce the concept of a Put option.
Like in a call option the buyer of the call option has the right to buy shares at a pre-agreed rate but he is under no compulsion to buy them. Similarly in a put option of a share, a buyer of a put option may, on payment of a premium, enter into a contract whereby he may sell shares at a pre-agreed rate but he is under no compulsion to sell.
Let’s assume that one thinks that the prices of a share may drop by the date of settlement from the price of 100 bucks to 80 bucks.and he buys a 120 bucks put option of the share today at a cost called ‘premium’ which goes to the seller of the contract. Now he has the contract whereby he may sell the share on the date of settlement at 120 bucks irrespective of whether it trades at 80 bucks on the settlement date. So on the settlement date he buys the shares at 80 bucks and sells them at 120 as per the contract. However, if the price of the share does not go down to 80 bucks and rises to 140 bucks on the settlement date then as he does not have to sell the shares compulsorily, he lets the contract expire and all he looses is the premium which is a minimal amount.
In this way he has maximized his gains and minimized his losses or in other words he has leveraged himself in a non-linear way.
Did these articles help you in understanding the concept behind Put and call option? Please write to us.
In the next article we will introduce how trading is done in options along with various strategies. (Click here for the next article, Part III )
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