A put option is Definition, features, conditions and examples

2024 Author: Howard Calhoun | [email protected]. Last modified: 2023-12-17 10:16

Option trading is one of the types of trading in the financial markets. According to statistics, the most popular type of options for traders is Put-option, which will be discussed in this article. The reader will learn what a put option is in simple terms, about its features, trading tasks and characteristics. And also examples will be given in the article.

Put option definition

There are two types of options in stock trading in financial markets:

• Put option;
• Call option.

A put option is an exchange contract for the sale of a trading asset. Unlike a put option, a call option is a standard exchange contract to buy. A put option allows the right holder to make transactions to sell without any obligations. That is, the owner of such an exchange contract has the right to further sell the selected trading asset subject to predetermined conditions.

Put option conditions:

• market price, which isfixed for the selected option;
• exchange contract expiration date;
• other parameters set by the exchange for a specific trading instrument.

A put option is an opportunity for a trader to trade on predetermined fixed conditions with selected exchange-traded assets. Any option has 2 main characteristics, that is, rights for buyers and sellers, which are very different. Call option holders are not required to sell the underlying trading assets, and put option sellers must always fulfill the corresponding obligations to sell under the exchange contract.

Types of Put options

In the modern financial market, a put option is a rather complex investment and financial instrument with great opportunities for trading and investment. It has its own characteristics and characteristics and differs according to two criteria: the execution period and the duration of the exchange contract.

This option can be of different styles by expiration:

1. European style - the transaction is considered completed only on the last day of the contract.
2. American style - a trade can be made throughout the life of the exchange option.
3. Asian style (rarely used by traders and less in demand).

And besides, exchange contracts are distinguished by types of trading assets:

1. Currency options.
2. Stock contracts.
3. Commodity contracts.

Currency Optionsinvolve trading in various world currency pairs, and in trading stock and commodity contracts, government and securities (bonds, company shares), various metals (gold, copper) and commodities such as oil, gas, coffee, wheat are most often used, wood, coal and other types.

Features and basic concepts

As mentioned above in the article, a put option is a contract to sell, and therefore, it can be used to make money in a downtrend. Each option has a premium, which, by and large, is the income of the right holder of this contract. The premium is the price that the buyer pays to the seller of an exchange option.

Each buyer who bought a put option for subsequent sale, within the framework of the expiration of the contract, can sell trading assets only at a fixed price prescribed in the contract. He cannot choose the most convenient conditions for himself, and it remains within his rights to accept them or refuse to sell. In trading, this price is called the Strike price. And also in the trading of Put-options, there is an intrinsic value, which is calculated as the difference between the prices of the trading asset on the exchange and the execution of the contract.

The option transaction is considered completed, and the contract is executed only after the sale of the investment exchange asset.

Option patterns

In modern trading, option pricing occurs according to various models, due tomarket conditions. The objectives of the put option are factors such as financial risks, which can be regulated by pricing models.

Types of models:

1. CAMP – financial risk management.
2. The Black-Scholes system is one of the most popular models that allows you to most effectively use the market volatility of the underlying option in trading.
3. The binomial system is used to evaluate the contract. Most often, this model is used in the American market, since it is permissible to open and close a transaction at any time before its implementation date or the end of the expiration time.
4. Monte Carlo system - this model calculates and evaluates the mathematical expectation based on the historical data of the trading asset. The bottom line is to find the average value and use it in trading.
5. Heston's system applies to the European market only. This model is based on the basis value redistribution hypothesis, which differs from the average algorithms and takes into account the random value of market volatility.

The Monte Carlo system and the Heston model are considered quite complex options for calculations, and therefore traders use specialized, often automated indicators and programs. It will take a very long time to make calculations in manual mode, and therefore this method is irrelevant.

Examples of a put option

For clarity and better understanding, the article will consider an example. Suppose a trader has chosen Sberbank shares as a trading asset. Their current priceis 150 rubles. The trader-buyer has acquired a put option under which he can sell 450 shares of Sberbank in the future at a price of 150 rubles. Taking into account possible losses (option price), financial risks will amount to 1000 rubles. This amount is the maximum risk. The profit on the transaction has no limit, but it is necessary to take into account the option price, that is, minus 1000 rubles.

Further development of the transaction will take place in one of two ways:

1. When the market quotes went down, the value of the asset went down and amounted to 140 rubles. In this case, the trader-buyer will use the right to sell the trading asset. Calculations: 150x450 - 140x450 - 1000.
2. If stock quotes rise in price, then there is no need for a trader to sell anything below the market price at all. However, do not forget that his loss will still be minus 1000 rubles. The higher the profitability of the asset, the greater the trader's earnings, since only a fixed price of 1000 rubles will be deducted from the total profit.

To track the growth or decline in the price of the selected trading asset, traders and investors use specialized tools, the main of which is the put option chart.

In closing

The put option allows the right holder to earn minus the cost of contact, since if the market quotes are below the strike price, then you can sell the investment asset and stay with a profit (under the terms of the contract). They are not subject to margin call, and the trader initially knows hisloss.