What is Put Option?

A put option provides you with the right to sell a security at a set price until a particular date. It gives you the option of turning down the security. A contract governs the right to sell a security. Stocks are commonly used as securities, but commodities futures and currencies can also be used.

The price is known as the - strike price because it is expected that you will strike when the stock price drops to that level or lower. You can only sell it up until a certain date. Because your choice expires on that date, it's known as the expiration date.

You exercise your put option in an American option if you sell your shares at the strike price before the expiration date. You can only exercise your put option on the expiration date in a European option.

How Do the Put Options Work?

If the price of the underlying stock or investment falls, a put option becomes more valuable. A put option, on the other hand, loses value as the price of the underlying stock rises. As a result, they are frequently utilized for hedging or to speculate on price activity in the negative.

Put options are frequently employed in a risk management strategy that is known as the protective put - which is a type of investment insurance or hedge that ensures that losses in the underlying asset do not exceed a predetermined amount. 

The investor uses this method to hedge downside risk in a stock held in the portfolio by purchasing a put option. The investor will sell the stock at the put's strike price if and when the option is executed. A short position in the stock is made if the investor does not own the underlying stock and exercises a put option.

When to Buy a Put Option?

When you buy a put option - you're guaranteed to not lose more than the premium you paid to buy that option. You pay the person who is willing to buy your stock a little charge.

Their risk is covered by the charge. They know you can ask them to buy it at any time during the agreed-upon timeframe. They also recognize that the stock could be worth a lot less on that particular day. However, they believe it is worthwhile because the stock price will rise. They'd rather have the money you give them in exchange for the small risk they'll have to acquire the shares, just like an insurance company.

When to Sell a Put Option?

You promise to buy a stock at an agreed-upon price when you sell a put option.

If the stock price falls, sellers lose money. As they must purchase the stock at the strike price but can only sell it at a lower price, this is the case. If the stock price rises, they profit since the buyer will not execute the option. The fee is kept by the put sellers.

Put sellers keep their businesses afloat by writing a large number of options on companies they believe will appreciate in value. They believe that the fees they collect will cover the losses they experience when stock prices decline.

Benefits of Put Options

Since buying an options contract entails determining whether to buy a put or a call option, it's critical to comprehend the benefits. A put option - on the other hand, has more advantages than a call option when compared to each other.

1. An option's underlying asset or stock can move in any way. Its value might fluctuate dramatically depending on social, economic, and political events. For a call option to be profitable for an investor, the option must be purchased at a price lower than the strike price.

Investors who buy a put option, on the other hand, might profit if the underlying asset's price stays the same or even falls somewhat. As a result, a put option trader is more likely to profit than a call option trader.

2. When it comes to derivatives trading, time is of the utmost importance if you want to make money, and options are a time-bound asset that gives sellers an advantage. The less valuable an option contract becomes as it approaches the end of its stated duration. 

As a result, put option sellers are more likely to profit from time decay by selling the contract while the option is still valuable. The individual who has the call option, on the other hand, is not favoured by time decay in this instance.

3. The cost of an option contract is referred to as implied volatility. When a market's implied volatility is high, the option contract's price tends to be higher. As a put option trader, you would want to sell when the price is high and purchase when the price is low. This is only conceivable when implied volatility is high but gradually reduces over time.

Market experts have long observed that high implied volatility has a natural tendency to decline over time, implying that traders who buy a put option would profit over time since the market's inherent conditions are in their favour.

Difference Between a Put Option and a Call Option