What is PUT OPTION
If you think a stock price is going to go down, then there are 3 trades that you can make to profit from a rising stock price:
- you can sell the stock
- you can buy put options on the stock, or
- you can write call options on the stock
Selling stock huge capital investment i.e.your total capital is @ risk plus u need to cover it cover intraday or supply delivery
Writing call option also need huge margin and risk associated with it is unlimited
Buying put option give u unlimited profit upside and limited risk downside.
Only enemy of put option is time so u should book your profits as early as possible.
Let’s understand using an example. Suppose, today’s date is 25-APR-2012 and you BUY a RELIANCE PUT option (strike=700, EXPIRY MAY 31) @ Rs. 10 per contract when RELIANCE stock was getting traded at 740. Let’s see what happens after options expiration.
Case I : Reliance stock price greater than the strike price on expiry day cut-off time
Net loss = Premium paid = Rs. 10 per contract
Case II : Reliance stock price less than strike price (700) on expiry day cut-off time i.e. 640
Net profit = (current price – strike price) - premium = (700-640 ) -10= Rs. 50 per contract
So when you buy a put option you have unlimited profit potential but limited risk or downside.