A put option is a financial contract between a buyer and a seller (also called a writer) through which the buyer receives the right to sell the underlying asset at a specified price before the expiry of a contract. This pre-specified selling price of an option is termed as the ‘strike price.’ For exercising the put option, the buyer needs to pays a premium to the writer.
Although the buyer of the put option has the right to sell the underlying, he is under no obligation to do so. However, the writer of the put option is under an obligation to agree to the transaction.
The underlying asset for a put option could be anything ranging from a bond to a commodity like crude oil. However, the most widely traded put options have equities as the underlying assets
Trading a Put Option
The put option, also called a “put,” is sold in lots. For example, a put option based on stock will be sold in lots of 100 shares. However, the premium of a put is quoted on a per share basis. A put can be exercised in either the American or the European way. The American way lets a put option to be exercised any time before the expiry date. The European way is that a put option can be exercised only on the day of expiry of the option.
Value of a Put Option
The buyer of the put option believes that an underlying asset’s price would fall before the date of the expiry of the option. On the contrary, the seller of the put option believes that such likelihood is extremely low. The main advantage of buying a put option is that the buyer’s risk in the underlying asset is limited to the premium. A put option also helps to limit the portfolio risk.
Put Option Strategies
In order to find the proper put option for purchase, decide your objectives and the time for which you want to remain in the market. Finalize the amount you want to spare for the put option. A last factor to consider is the kind of approach (conservative or aggressive) that you will follow in the market.