If you want to start investing in different assets then you must start with knowing the different terminologies of the financing world. There are a lot many different terms that you won’t be aware of. Put options, buying a put, call options are some of the terms that you may have heard from someone.
You must know these terms as they are important and for investing in assets, it is a must that you get familiar with them. We will give you an overview of what is a put, selling a put and other details in this article so read it on and get acknowledged.
What is a Put Option?
Put options give the buyer a right to sell any stock, commodity, bonds, etc. at a set price at any time up to the expiration date. There is a difference between the European style and the American style. In American style, buyers can sell the commodity any time on or before the expiration date while in the European style, one can sell it only on the expiration date.
Now, there are some terms that you need to understand for the put option.
Strike price: The fixed price of an option at which the buyer can buy/sell the commodity is called the strike price. If the commodity price goes down then also the buyer can sell the commodity at the strike price that is finalized at the time of creating the contract before the expiration date.
Spot price: Spot price is the market price of the commodity when the option is taken out.
Premium: The amount that the buyer needs to pay to the seller of the commodity just to confirm it is called the premium. It is an amount to be given to the seller.
Expiration date: The date on which the contract between the buyer and seller ends is called the expiration date.
Let’s understand it with an example.
If someone buys a put option contract for company A for $1/share for a 100 shares contract with a strike price of $10 per share. This means that the person can sell the shares at $10 before the expiration date.
Now, if the share drops to $8 per share then the person can buy the shares and sell the put option at $10/share. $8 is the spot price.
What Benefit Does the Put Buyer Get?
Let’s say the price of a commodity goes down to $10 but the strike price is set to $20 then the Put Buyer can sell it on the strike price before the contract ends. To get this right, the buyer pays a premium amount at the time of starting the contract.
If the price of the commodity gets down below the strike price then the buyer will earn a profit. The formula for calculating the profit is mentioned below:
Profit/Loss= Strike price – Spot price – Premium
Premium is the amount paid at the time of booking the contract.
The strike price is the agreed-upon price on which the buyer can sell the commodity.
The spot price is the current value of the commodity.
What the Put Seller Gets?
Put seller is the one who does the contract with the buyer. He gets the premium that the buyer pays to him. Writing a put option won’t give that much income. The buyer will be earning more profits as compared to the premium generated by the put seller.
Now, there are three terms for comparing the strike price and the spot price of the commodity.
In the money – This means that the commodity is having a spot price below the put strike price. This will be a profitable situation.
Out of the money – This means that the spot price of the commodity is above the strike price. This will generate loss if the commodity is sold at this time.
At the money – This means that the strike price and the spot price of the commodity are the same. This will be a no profit, no loss situation.
Similar to the Put option, there is a call option in which the trader buys the commodity. Have a look at the below-given points which will give you a brief but important idea as to what happens in the buying and selling call/put options.
- Buying a call: The buyer has the right to buy a commodity at a predetermined price.
- Selling a call: Seller will have an obligation to deliver the commodity at a predetermined price to the buyer if they exercise the option.
- Buying a put: The buyer has the right to sell a commodity at a predetermined price.
- Selling a put: Seller has an obligation to buy the commodity at a predetermined price from the buyer if they exercise the option.
Benefits for the Sellers in Put
If you are comfortable owning the commodity then only you should sell put options. Once the buyer exercises this option then you have to buy it.
Also, the sellers should only deal in those markets and commodities where the stock, share, bonds, or any other thing is attractive and where the net price paid is high.
The potential benefit can be seen when the buyer doesn’t exercise the option before the expiration date and this gives the complete premium to the seller. When the seller owns the commodity below the current market price then it will be of a high value to them.
Also Read: What Is Stock Exchange And How Does It Work?
What Is a Long Put?
Long put refers to that situation when one buys a put without owning the commodity.
What Is a Protected Put?
Protected Put is referred to in that situation when one buys a put on a stock they already own.
There are two more terms: naked put and cash-secured put sale. The description of the same is mentioned below.
Naked Put: When one doesn’t keep enough in the account to buy the stock then it is called Naked Put.
Cash Secured Put Sale: When one keeps enough money in their account to buy the stock or cover the put then it is called a cash-secured put sale.
On Which Assets Are Put Options Available?
Put options are available on a wide range of assets like stocks, bonds, currencies, indexes, commodities, etc.
After getting an overview of the put option, let us check out what a call option is.
What Is a Call Option?
Opposite of the put option, a call option gives the right to the trader to buy the commodity within a specified time frame. They are not obliged to buy the commodity but they can if they see a valuable investment in it.
If the spot price is high then the buyer will find it profitable to buy the commodities. He would have to buy it at the strike price which would be less than the spot price and so he will earn the profit.
Here also, there are two styles. In the US-style call option, the trader can buy the commodity any time before the expiration date at the strike price while in the European style, it can be bought only on the expiration date.
So, here was an overview of selling put options. Hope you got clear information about the same and now can clearly understand what a finance broker is trying to explain to you about the same anytime you want to invest in the future.