Updated on March 11, 2023
Option is a prominent form of ‘derivatives’,which is a contract whose value is based on another commodity or product. A financial derivative’s value is derived from another financial asset, which is known as an ‘underlying asset’. An options contract gives the buyer (or seller) the ‘right’, but not the ‘obligation’ to buy (or sell) a particular asset on a predetermined date and at a certain price (depending on the price, the contract may or may not be executed).
How does a Put option work?
As per a Put options contract, a trader may ‘sell’ the asset at a predetermined price in the future, but there is no ‘obligation’ to sell.
For example – If the trader has a contract to ‘sell’ the shares of Company ‘T’ for Rs. 400 in future, and the share price rises to Rs. 500 before the expiry, then the trader will have the option of not selling the shares for Rs. 400. Thus, s/he can avoid a loss of Rs. 1,00,000 (400×1000 – 500×1000).
A trader would normally buy put options when prices are expected to move down.