The buyer (holder) of a put option acquires the right to sell a specified security at the specified price on or before the specified date by paying a premium to the seller (writer) of the option.
Contract Performance
The holder of the put option has a choice of whether or not to perform the contract. If he chooses not to make the sale of the specified security to the writer of the put option, he will have to forgo the premium that he had paid for the option.
The writer of the option is contractually bound to perform his part of the contract.
Example
- Rahul purchases a put option at Rs.500/- per share with a premium of Rs.25/- per share;
- During the validity period, if the share price falls by more than Rs.25/-, say to Rs.470/-, Rahul stands to make a profit by purchasing shares in the spot market and exercising his option;
- His total price per share would be Rs.470/- (spot market price) + Rs.25/- (premium paid) = Rs.495/- but the writer of the option will have to pay him Rs.500/-;
- If the share price falls, Rahul could exercise his option and recover a part of the premium paid;
- If the share price rises, he can elect not to exercise his option. He will then lose only his premium
