Put Option Examples

Put option examples refer to hypothetical or real-life instances that provide an inexhaustive list to help the readers understand how some of the most common put options execute and how they have become an important part of portfolio management, hedging, and speculation tool for making leveraged trades.

Put Options are derivative instruments that enable their buyer a right but not an obligation to exercise his right to sell a particular security at a pre-specified price, popularly known as the strike price, on the date of the expiry of such a derivative contract.

• Put options are contracts allowing the buyer to sell a specific security at a set price on the contract's expiration date. The buyer has the right to sell but is not obligated to do so.
• In several financial and portfolio scenarios, options are helpful. It is also successfully used for hedging by long-only funds and to protect investors from losses in the case of economic turmoil.
• To provide a good return with little risk, they can be utilized in various options strategies, including selling underlying stock futures or combining them with call options.

Put option examples indicate the scenarios when stocks are put for sale. It is the contract that makes sellers and buyers exercise their respective rights, without making it an obligation, to sell those securities at a prespecified price before the expiration is reached.

The put options are more active when the prices of the stocks start falling. It is because, for the sellers, this becomes the right time to earn from those stocks at a predetermined price, which, of course, is more than the currently running prices.

Since these options provide a right but not an obligation on the buyer, the buyer of a put option can make the right go worthless if the value of the underlying falls below the strike price (since in such a case exercising the put option is futile as the underlying security can be bought at lower levels directly from the exchange) where the security is listed/traded.

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 the downside in case of financial turmoil.

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

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 war, and poor administration, and intends to safeguard the portfolio without liquidating the securities. Michael Shane, the young portfolio manager, 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-money 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.

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 overbought 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 spread (buying a put at the strike price 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.

Example #3

They are a great derivative instrument 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 bearish 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: 3000
• Strike Price: 2700PE
• Current Date: 12-Mar-19
• Expiry Date: 30th June 2019
• Put Premium: $20
• Lot 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 option 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.

Example #4

Large institutional players with huge holding in particular securities also write put options 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.

Let us look at the following put option purchaser’s payoff graph to better understand the concept.

As one can observe, the above diagram shows the losses or profits generated by a trader who purchased a 3-month XYZ index put option at 34,000. Let us assume that David, the buyer, purchases the put option for a $200 premium. In other words, David spends $20,000, i.e., $200 x 1 XYZ lot or 100. Thus, the premium becomes $19,800 ($20,000 - $200). This means David will start making gains only if the spot price drops under 19,800 or if the strike price is In The Money or ITM.

 The profit will continue to rise as the XYZ index continues to reach the lower levels. Upon expiration, if the index closes under the strike price of 20,000-200, David would exercise the option. In The process, he would make a total profit of up to the difference between the Nifty close and 19,800. Anywhere over the breakeven point, this option is unfavorable for David, and he cannot exercise the action. That said, if the XYZ index closes under the breakeven point on the day of the expiry, David can make a profit. Note that the total profit amount will be dependent upon the closing spot price at the time of expiry.  

One can clearly understand from the above graph that David’s potential profits on this option have no maximum limit.

This has been a guide to what are Put Option Examples. Here, we explain the concept by citing the top 4 practical examples along with detailed explanations. You can learn more about financing from the following articles –

• Bear Put Spread Strategy
• European vs. American Option
• American Options Meaning
• Writing Call Options