Demystifying Put Options: A Comprehensive Guide for Beginners
Today I'm going to explain how to buy a put option of a stock using the Upstox trading platform. The process works similarly on other popular Indian brokerage platforms like Zerodha, but I'll focus on Upstox in this example. We have also given link to Malayalam video in this topic below. Check that also.
Buying a put option gives you the right, but not the obligation, to sell a stock at a predetermined "strike" price before a set expiration date. It's a way to profit if you think the stock price is going to fall. The put option trading screen on Upstox may look complicated at first, but I'll walk you through step-by-step how to place the order.
By the end, you'll understand all the key terms and mechanics involved in purchasing put options. Although it may seem complex, it follows a logical order similar to buying regular stocks. I'll translate the jargon into simple concepts so you feel confident about trading options.
Understanding Put Options
A put option serves as a derivative contract, granting the buyer the right (not obligation) to sell a specific asset to the put option seller within a defined timeframe.
How Put Options Work
- Put option buyers pay a premium upfront to acquire the right to sell the underlying asset at a set strike price before expiration
- Sellers of put options collect this premium in exchange for the obligation to buy shares if the put option is exercised
Scenarios at Expiration
- If the share price stays ABOVE the strike price, the option expires worthless and put buyers lose just the premium paid
- If the share price DROPS BELOW the strike price, the put option is “in-the-money” and can be exercised by selling shares at the higher strike price to generate profit
Uses of Put Options
Puts can be used to:
- Speculate on falling stock prices
- Hedge downside risk in a portfolio
- Employ options spreads trading strategies
- Profit even when neutral/moderately bullish on the underlying
In summary, put options transfer downside risk to the option seller. For buyers, it limits losses in exchange for the premium paid while retaining the ability to profit from a drop in asset price.
Buying a Put Option
3.1 Strategy: Bearish Outlook
Investors opt to buy a put option when they hold a pessimistic view of the underlying asset. The put option buyer profits when the asset's value decreases.
3.2 Intrinsic Value Calculation
The intrinsic value (IV) of a put option is calculated as follows:
Intrinsic Value (Put Option) = Strike Price - Spot Price of Underlying Asset
3.3 Profit and Loss Calculation
The profit and loss equation for the purchaser of a put option contract is defined as:
P&L = [Max(0, Strike Price - Current Spot Price)] - Put Premium Paid
Breaking this down into its components:
Max(0, Strike Price - Spot Price) represents the intrinsic value calculation covered previously. This quantifies the in-the-money amount at present.
The put premium paid is then subtracted to determine net P&L.
For example, take a trader who purchases a Nifty put option with a ₹18,000 strike for a premium of ₹500. If the Nifty subsequently declines to 17,000, the P&L is:
= [Max(0, 18,000 - 17,000)] - 500 = (1,000) - 500 = ₹500 Profit
By accounting for the initial put premium paid, traders can accurately evaluate profit potential at any stage. This informs decisions on when to exercise the option to realize gains versus remaining open to benefit from further downward trajectories. Mastering such precise calculations is key to improving trade outcomes.
3.4 Breakeven Point
A key skill for profitable put trading is determining the breakeven level - the exact point where net gains become realized. Quantifying breakeven guides decisions on appropriate strike prices relative to risk tolerances.
The formula for calculating a put option's breakeven point is:
Breakeven Point = Put Option Strike Price - Premium Paid
For example, consider a trader buying a Nifty put option with a strike price of 18,000 for a premium of ₹500. The breakeven point is computed as:
Breakeven Point = 18,000 (Strike Price) - 500 (Premium Paid) = 17,500
This means the Nifty index would need to trade below 17,500 for this 18,000 strike put trade to break even and start generating a profit. As the premium paid increases, so does the breakeven level.
Monitoring the changing breakeven point relative to current and expected Nifty levels allows traders to assess when to enter put trades, which strikes to utilize based on market outlooks, and when to exercise options to lock in profits. Equipped with this key quantitative insight, retail traders can substantially improve put trade profitability.
Selling a Put Option
4.1 Strategy: Bullish on Stock
Selling a put option is an approach taken when one is optimistic about a stock or believes its price won't decline further. The decision to sell a put option is influenced by the attractiveness of the premium.
4.2 Premium Evaluation
Premium evaluation, coupled with Option Greeks, provides insights into the attractiveness of premiums.
4.3 Risk and Reward
When creating options trading strategies, accurately quantifying the maximum upside profit and downside risk forms a vital component. While put buyers enjoy unlimited profit potential during market declines, put option sellers face capped gains but uncapped losses.
On the put purchase side, the previous profit formula applies:
P&L = [Max(0, Strike Price – Spot Price)] – Premium Paid
As the Nifty spot price falls well below the strike, the intrinsic value rises exponentially while risk is limited only to the known premium outlay.
Conversely for put sellers, the payoff profile is:
P&L = Premium Received – [Max(0, Strike Price – Spot Price)]
The key distinction lies in the uncapped max(0, Strike Price - Spot Price) term. During sharp index declines, losses accelerate lower without limit as the short put position is forced deeper in-the-money.
For example, an 18,000 strike put seller collecting ₹500 premium would realize a ₹1,500 loss if the Nifty drops to 17,000 at expiration. Beyond quantifying the differing risk-reward profiles, this highlights the importance of risk management utilization like stop losses to limit the downside.
Armed with this precise understanding of the dual perspectives of put trading, retail investors can construct balanced options strategies that effectively align profit targets with measurable risk tolerances.
4.4 Margin Requirements
Selling a put option involves the necessity of depositing margin, ensuring responsible trading practices.
Option Premium Pricing and Option Greeks
Understanding option premium pricing and Option Greeks is crucial for gauging market dynamics and making informed decisions.
How to buy put option in upstox
Step-by-step process of buying a put option on Upstox specifically. Even though different brokers have minor interface variations, the overall concepts remain aligned.
If you don't have an upstox account, you can open with this link - Upstox
Here are the key steps to buy a put option on Upstox:
Step 1) Login to your Upstox trading account and navigate to the Derivatives section from the left menu.
Step 2) Choose the "NFO - Index & Stock" tab to bring up the option chain for picking the desired underlying stock.
Step 3) Use the filters on top to set the expiry date and strike price range as per your trading plan.
Step 4) Now select the PUT option you intend to purchase. You will see its premium quoted.
Step 5) Click the "Buy" button which fills in a pre-order ticket. Verify if all details including strike price, expiry etc. are accurate.
Step 6) Enter the quantity of put option contracts you wish to buy and set the rate/premium you are willing to pay.
Step 7) Click on "Buy PUT" button to place the order and complete the trade.
The order gets filled as per market depth and liquidity at/around the rate specified by you.
I hope this gives you a good overview of practically buying a put option on Upstox platform. Feel free to ask any other questions!
Check this video about put options in Malayalam - https://youtu.be/2SBzIVJGUJk?si=O3I4UIBYiuoWCKAR
Frequently Asked Questions
6.1 How do I assess the attractiveness of option premiums?
Premium evaluation, along with Option Greeks, offers insights into the attractiveness of premiums.
6.2 What are the risks associated with selling a put option?
Selling a put option entails limited profit (premium received) but potentially unlimited losses.
6.3 Do different brokers have variations in the process of buying call options?
While specifics may vary, the fundamental process is analogous across brokers like Zerodha, Fyers, and Upstox.
Watch video in our youtube channel for more details in Malayalam. I have explained in detail how to buy and sell put options also there.
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