Understanding Put Options: A Simple Guide to Trading

What is a Put Option?

A put option gives you the right, but not obligation, to sell an underlying asset at a fixed strike price within a set period. In fact, you might pay a premium to buy this right. If an asset price falls, the contract may gain value because you still have the right to sell at the agreed strike price.

Securities and Exchange Board of India (SEBI) explains that an option gives a buyer the right, but not an obligation, to exercise at your predetermined price and date. A put gives a buyer the right to sell an underlying security. 

•  Right to Sell: You get the right to sell an underlying asset.
•  Strike Price: You agree on a price at which you can sell.
•  Premium: You pay this amount to buy a contract.
•  Expiry: The contract remains valid only for its specified period.

How Do Put Options Work?

A put option generally gains value when its underlying asset falls in price. If the asset price rises, its value may decrease. Strike price, premium, and remaining time also affect its value and your final result.

• Price Falls: When the underlying price falls, the contract may gain value because you hold your right to sell at the fixed strike price
• Price Rises: When the underlying price rises, the contract may lose value because selling at a fixed strike becomes less attractive
• Premium Matters: You might pay your premium when you buy the contract. So that price fall must cover this cost before you make an overall profit
• Expiry Matters: Time affects the value of your contract, and a buyer may lose the premium if the expected price movement does not happen before expiry.
• Hedging Use: You may use a put as a hedge against a fall in an existing holding, although the premium adds a cost.

For example, assume a stock trades at ₹100, and you buy a ₹100 strike contract. If the stock falls to ₹85, your right to sell at ₹100 becomes more valuable. Besides, you still need to consider the premium before calculating your actual gain or loss. 

However, SEBI explains that derivatives derive their value from an underlying security or financial instrument and may serve hedging, speculation and arbitrage purposes. 

When Should You Buy a Put Option?

You may consider buying a put when you expect a possible fall in an underlying asset or want to hedge an existing holding. In fact, you generally pay the premium upfront. So the price movement needs to cover this cost for the position to show an overall gain.

• Bearish View: You expect the underlying price to fall and want a position that may gain value from that decline.
• Downside Hedge: You hold an asset and want a contractual selling price that may reduce the impact of a price fall.
• Risk of Buyer: Your loss generally stays limited to the premium paid, excluding applicable charges as well as costs.
• Favourable Movement: A larger fall in the underlying can increase intrinsic value and may improve the result of a position.
• Expiry Pressure: You might need enough favourable price movement before expiry because time works against a buyer when other factors remain unchanged.

Suppose you own shares and expect a short-term decline. Buying a put gives you a right to sell at your selected strike price. If the share price falls sharply, the contract may gain value and partly offset the decline in your holding. However, a falling share price does not automatically create a profit because you must also recover the premium and applicable costs.

When Should You Sell a Put Option?

Selling a put generally creates a different risk pattern from buying one. You might receive a premium upfront, but you also take on an obligation if the buyer exercises the contract under its applicable terms.
If the underlying stays above the strike price, the buyer may not exercise the contract and you may keep the premium. However, a sharp fall in the underlying can increase your potential loss because you must meet your obligation at the agreed strike price.

• Premium Received: You may collect a premium when you sell the contract, which becomes your maximum possible gain from the position.
• Price Stays Higher: If the underlying stays above the strike price, the buyer may not exercise, allowing you to retain the premium.
• Price Declines: A fall below the strike price might increase your downside exposure because the contract moves against your position
• Buyer Exercises: If a buyer exercises, you might ned to meet your obligation according to the contract terms and settlement process
• Loss Potential: A sharp fall in an underlying can generally create substantial losses for the seller.

Buying gives you a right, while selling creates an obligation. In fact, you receive a premium for accepting that obligation, but your risk can rise sharply when the underlying moves against your position.

What are the Benefits of Put Options?

A put gives you a fixed strike price for selling an underlying asset and provides a way to manage downside exposure. Besides, its usefulness always depends on factors such as the underlying price, strike, premium and expiry.

• Downside Protection: You can use a put to reduce the impact of a fall in an existing holding.
• Defined Buyer Risk: When you buy one, your maximum loss generally stays limited to the premium paid, excluding applicable costs.
• Flexible Exposure: Different strike prices and expiry dates let you structure positions around different market views.
• Declining Market: A fall in the underlying may increase its value and change your overall position.
• Hedging Use: Derivatives may help you manage the impact of unfavourable price movements.

Investors can use derivatives mainly for hedging and reducing price risk. It also recognises speculation and arbitrage as other purposes for using derivatives. Time also affects an option because every contract has a fixed expiry. As expiry approaches, a buyer faces the risk that the expected price move may not happen quickly enough to cover the premium paid.

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How Does a Put Option Differ From a Call Option?

A put and a call give buyers different rights. A put generally gives the right to sell, while a call gives the right to buy. In fact, the market view, purpose and payoff direction therefore change between the two contracts.

A table below shows some basic distinctions without treating either contract as universally better. In fact, your choice might depend on the underlying asset, market view, risk exposure and contract terms.

A put does not automatically suit a bearish market view, nor does a call guarantee a profitable bullish position. Premium, expiry, as well as the size of the underlying price movement all affect the final result.

How Can You Trade Put Options in India?

Trading put options in India generally requires a trading account with access to the relevant derivatives segment and an understanding of a contract before placing an order. Now, do you want to know in detail “how to trade put options?” Let us discuss them below:

• Open an Account: You might need to maintain the required trading and Demat account arrangements.
• Understand Options: Learn how premiums, strikes, expiry and payoffs work.
• Select the Underlying: You may choose a stock or other eligible underlying available for options trading.
• Choose the Strike: Select a predetermined price linked to a contract.
• Check Expiry: Review the date on which your contract ends.
• Select Position: Buy a put or sell a put based on your intended structure.
• Monitor the Position: Track changes in the underlying price and option value.
• Exit the Position: Offset the position or follow the applicable exercise and settlement process.

For a put buyer, selling a purchased contract before expiry can close the position. For a put seller, buying back a contract can offset the earlier position. Exercise and settlement depend on the applicable contract specifications and exchange rules.

Final Thoughts

A put option generally gives you the right to sell an asset at a fixed price within a specific period of time. Investors often use it to manage downside risk or take a view on falling prices. However, the premium, strike price and expiry can easily affect the outcome.

So before using any options contract, you might ned to be sure that you understand how it works, the risks involved and the obligations that may arise.

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