Put Option Definition & Examples

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Top 4 Examples of Put Option

The following are examples of the put option for your better understanding.

Put Option Example #1

Let’s understand how they are helpful in the hedging of the portfolio through the below example:

Seed Venture is an investment management firm that manages a portfolio of a basket of securities on behalf of its clients across the globe. The firm is holding multiple stocks forming part of NASDAQ and is concerned that the index will fall in the next two months owing to dismal corporate earnings, trade warTrade WarA trade war occurs when one country raises its tariff on imports, and the other country responds by raising its own tariff to restrict imports.read more, and poor administration, and intends to safeguard the portfolio without liquidating the securities. Michael Shane, the young portfolio managerPortfolio ManagerA portfolio manager is a financial market expert who strategically designs investment portfolios.read more, suggested opting for a protective put strategy under which the firm purchased put options on the index as a hedge against its holdings in the constituent’s securities forming part of the index.

The seed navigated its portfolio from losses by hedging the same through purchasing put options. The firm bought at-the-moneyAt-the-moneyATM refers to a situation in which the option holder’s exercise of the option results in no loss or gain since the exercise price or strike price is equal to the current spot price of the underlying security. read more put options for next month’s expiry equivalent to its holding to make it delta neutral. At the end of the next month, Nasdaq fell by 10 percent, and the losses in its securities were adjusted with profit input options purchased by it.

Put Option Example #2

They can be used under various options strategies and selling underlying stock futures or by combining them with the call options to generate a good return with limited risk. Let’s understand this utility with the help of another example:

Shane, a seasoned trader, believes that the Facebook share is highly overboughtOverboughtOverbought refers to market scenarios where stock is traded considerably higher than its fair value.read more and the quarter results scheduled next week don’t justify the premium valuations; however, at the same time, he’s skeptical about any favorable news regarding merger from Facebook, which can hold the share of Facebook from a big downside. He believes that the price of Facebook inc. Currently valued at $80 by the market will move down significantly in the next month and can hit $70 but believes that below $70, the stock may find support due to the recent QIP issue at $70. He intends to make money through this move by taking a hedged risk.

Shane created a bear put spreadA Bear Put SpreadBear Put Spread is an options trading strategy that involves buying a nearby strike, or In-the-Money put option while selling the far-off strike or Out-of-Money put option & this is used when you can expect a moderate fall in a security’s price. read more (buying a put at the strike priceStrike PriceExercise price or strike price refers to the price at which the underlying stock is purchased or sold by the persons trading in the options of calls & puts available in the derivative trading. Thus, the exercise price is a term used in the derivative market.read more of $80 and selling a put at the strike price of $70, both having next month’s expiry). The total cost comes out as follows:

Thus his total cost is as follows:

The total cost of the strategy, also known as a bear put spread = (100*$6)-(100*$3)

Total Cost = $300

Now by entering into this strategy, Shane profit/loss potential on expiry will be as follows:

Thus using put option strategies and keeping the amount of investment low, Shane can create a hedged put position on the stock of Facebook inc.

Put Option Example #3

They are a great derivative instrumentDerivative InstrumentDerivatives in finance are financial instruments that derive their value from the value of the underlying asset. The underlying asset can be bonds, stocks, currency, commodities, etc. The four types of derivatives are - Option contracts, Future derivatives contracts, Swaps, Forward derivative contracts. read more to indulge in speculation and make handsome gains when markets crash. Let’s understand that with the below example:

Ryan is a full-time trader based out of California, highly bearishBearishBearish market refers to an opinion where the stock market is likely to go down or correct shortly. It is predicted in consideration of events that are happening or are bound to happen which would drag down the prices of the stocks in the market.read more on the s&p 500 index, which is presently trading at 3000 levels. He believes the global economic environment is pessimistic, the recession in the US is not far away, and he expects the market to fall badly. He believes that the S&P 500 index will easily fall to 2500 within two months and decided to purchase a huge quantity of put options with a strike price of 2700. Details of the same are mentioned below:

  • Current Price: 3000Strike Price: 2700PECurrent Date: 12-Mar-19Expiry Date: 30th June 2019Put Premium: $20Lot Size: 250

The above numbers signify that Ryan will be in profit if S&P 500 index closes below 2680 on the expiry day (after adjusting for the premium cost, for simplification, we are assuming it is a European optionEuropean OptionA European option can be defined as a type of options contract (call or put option) that restricts its execution until the expiration date. In layman’s terms, once an investor has purchased a European option, even if the underlying security’s price moves in a favourable direction, the investor cannot take advantage by exercising the option early.read more that can be exercised only on expiry)

S&P 500 index closed at 2600 levels on the date of expiry. And Ryan made a jackpot return on the expiry date equivalent to $80 (after adjusting for the $20 paid by him)

Points Gained at Expiry= 2700-2600 =100 Points

However, if S & P closed above 2700 levels on expiry, the maximum loss suffered by Ryan will be equivalent to the premium he paid on the put options as the option will be worthless.

Put Option Example #4

Large institutional players with huge holding in particular securities also write put optionsWrite Put OptionsWriting put options refer to the opportunity availed by an investor to own and sell an underlying asset at an exceptional pre-determined price on a future date. The owner has the right but not the obligation to sell off the underlying asset.read more to magnify their return. Due to the sheer holding, they can control the prices of such securities, making the put options worthless for such put option buyers and pocketing the premium they receive from selling such options.

Conclusion

Options find their utility in many investment and portfolio applications. Apart from being extensively used for speculation, it is well used in hedging by long-only funds and to protect investors from downside in case of financial turmoil.

This has been a guide to put options examples. Here we discuss its definition, the top 4 practical examples of a put option, and detailed explanations. You can learn more about financing from the following articles –

  • Bear Put Spread StrategyEuropean vs. American OptionAmerican Options MeaningWriting Call Options