The Basic Put Option
A put option provides an investor with the right, but not the obligation to sell a stock at a specific price.This price is known as the strike, or exercise price.
If you believe a specific stock or market will go downwards in near future you buy plain put option for that particular stock or index.The price of this option moves opposite to underlying security price.
Writing Put Options for Income
Buying a put option is similar to going short on a stock, or profiting from a fall in the stock price. However, an investor can also short, or write a put option. This lets him or her receive income in the form of receiving the option price and the hope is the stock remains above the strike price. If the stock falls below the strike price, the put writer has the obligation to buy the stock (because it is effectively “put” to him or her) from the put option holder. Again, this occurs if the stock price falls below the exercise price.
When writing put options, the investor who is short is betting that the stock price will remain above the exercise price during the term of the option. When this happens, the investor is able to keep the premium and earn income from the strategy.
Combining One Put with Another Option
To create a more advanced strategy and demonstrate the use of put options in practice, consider combining a put option with a call option. This strategy is known as a straddle and consists of buying a put option as well as going long a call option. In this case, the investor is speculating that the stock is going to have a relatively significant move either up or down.
For example, assume a stock trades at Rs 1000. The straddle strategy can be relatively straightforward and consist of purchasing both the put and call at a strike price of 1000. Two long options are purchased with the same expiration date and a profit is reached if either the stock moves up or down by more than the cost to purchase both options.
Looking at an actual stock, shares of Reliance recently traded around 1000 per share. A call option trades at Rs 14 and a put option trades at Rs 15 for a total cost of Rs 28 for a single contract. In this case, the stock would have to move up past Rs 1028 for the call option to start to pay off and below Rs 972 for the put strategy to start to pay off.