This is going to be a short one if you already know what’s an option.
In simple words, a put option is similar to insurance. For e.g., you own a small café worth ₹10 lakhs near Chandni Chowk in Delhi. The place has seen some clashes recently and you fear that GoI might ask shop owners to halt all the activities near that area indefinitely.
Fearing this, you call up your rich neighbor, Amisha and offer him a deal. The deal asks for a coverage of ₹10 lakhs (strike price) at a premium of ₹50K for 2 years, ending 31st March 2023 (expiration date). Amisha agrees and you have a deal. A put option, so to say.
Now, any of the below two scenarios can play out: (1) Nothing happens, and you play Ali Sethi all day long (2) People march to Red Fort, situation turns violent, politicians camp near the area and journalists ask for Poha at your café. Your café is worth ₹2 lakhs with this.
If (1) happens, you are safe. You paid a small amount, but you hedged your risk too, so that’s fine. If (2) plays out, then you can boldly go to Amisha (before 31st March 2023) and ask for your strike price because you had a deal. You exercised your put option.
FAQs
Summary: call options – bullish bet; put options – bearish bets.
Why would you use them? Either to hedge long or to speculate price variances
What type of financial instruments are these? Derivatives like futures, forwards, swaps
Okay, what did you just write? I’ll explain in other 101s. This was supposed to a short one.
Thanks!