Buying a Put Option
Buying a Put Option​
Buying a put option gives traders the right, but not the obligation, to sell an underlying asset at a predetermined strike price before the option expires. A put option is typically used when you expect the price of the underlying asset to decline.
Example​
Let’s say Reliance Industries is trading at ₹850. You buy a put option with a strike price of ₹850 by paying a premium of ₹20. There are two potential outcomes at expiry:
- Price Falls: If the price drops to ₹820, you exercise your option, selling Reliance at ₹850 while it’s trading lower, profiting from the difference (₹30 - ₹20 = ₹10 net profit).
- Price Rises: If the price stays at or above ₹850, you don’t exercise the option, and your loss is limited to the premium paid.
Why Buy a Put Option?​
- Bearish Market Outlook: Put options are best suited when you expect a decline in stock prices.
- Limited Risk: The maximum loss you incur is the premium paid, but the profit potential is substantial if the stock drops significantly.
- Leverage: Similar to call options, buying a put option lets you control a larger position with a small premium.
Intrinsic Value and Breakeven​
The intrinsic value of a put option is the difference between the strike price and the spot price (but only if the spot price is lower than the strike).
Example: If Reliance is trading at ₹820 at expiry, the intrinsic value is ₹30 (₹850 - ₹820).
To calculate your breakeven point, subtract the premium from the strike price. In this case:
Breakeven Point = ₹830 (₹850 - ₹20).
You’ll only start making a profit once the price falls below ₹830.
Payoff Structure​
Here’s an example of the payoff structure for the Reliance put option:
| Price Movement | Intrinsic Value | Profit/Loss |
|---|---|---|
| ₹820 | ₹30 | +₹10/share |
| ₹830 | ₹20 | 0 (breakeven) |
| ₹850 | ₹0 | -₹20 (premium loss) |
Conclusion​
Buying a put option is a strategic way to profit from falling markets with limited risk. AlgoTest users can leverage the Strategy Builder and Simulator to develop and test put option strategies before executing them in live markets.