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PUTS are the opposite of calls. We shall illustrate this with an example.

X, a farmer, is worried that the price of tomatoes, which are now in the 300 - 320 range, will fall in the near future. Therefore, he calls a vegetable dealer and strikes a deal with him to sell the tomatoes at Rs 250 per box, in case he does not get a better deal in the market. The vegetable dealer overjoyed on getting a low price accepts to purchase the tomatoes any time from X. The vegetable dealer is of the view that the tomato price would remain in the 290-310 range. However, he is doubtful of his judgment and to compensate the risk of him not having the tomatoes in case X gets a better deal, he demands a token money. X pays him the token money.

In the above example, the option of selling the boxes to the vegetable dealer is that of a `put option'. X would sell to the dealer if the prices were below 250. He would walk out of the deal if the prevailing prices were above 250 and sell in the open market. The vegetable dealer, on the other hand, has the obligation to buy the boxes from the money. The token money paid is the premium paid for that put option.

** A `Put' gives the holder the right to sell an asset at a certain price within a specific period of time.

** Puts are very similar to having a sell position on a stock.

** Put holders - the buyer of a put is not obligated to sell. He has the choice to exercise the right to sell.

** Put writer - the seller of a put is, however, obligated to buy. This means that a seller may be required to make good his promise to buy.

An Example: Here is how equity put option works. Suppose, HPCL is selling at Rs 280 and X purchases a May put option with strike price at Rs 300 paying a premium of Rs 25. The option will be exercised on the expiry date if HPCL's spot price on that date is less than 300 levels. Since the options are cash settled the holder will be paid the difference on exercise. In case the price of HPCL is more than Rs 300, it makes no sense to exercise the option and sell the stock, when it can be sold at a higher price in the spot market.

** The gain for a put holder on exercising the option is the difference between the exercise price and the current market price.

** The holder will be in-the-money (ITM), when the exercise price is more than the current market price (300 {gt} 280).

** However, practically speaking, the holder breaks even only when the strike price and premium paid is more than the current market price.

** Put buyer's net gain = Strike price - market price - premium

** The holder is out-of-the-money (OTM), when the exercise price is less than the market price. The loss is limited to the premium paid - protected downside.

Put buyers have a view that the stock will decrease substantially before the option expires - that is a bearish view on the underlying asset.

If you have any queries relating to the futures/options markets and strategies that can be used in these markets, please mail them to Futures & Options, Kasturi & sons, 859-860, Anna Salai, Chennai 600 002 or email them to vaidy@thehindu.co.in with a mention of futures/options in the subject line of the mail.

C. Raja Rajeshwari

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