Amit owns some shares of Z Corp, currently priced at Rs. 300. He is afraid their prices might fall. Another investor, Vinod, thinks Z Corp shares are stable & fairly priced.
So, Amit & Vinod sign the contract of “Put-Option”, by which Amit gains the right to sell & Vinod becomes obligated to buy the Z Corp shares in a month’s time at an agreed price of Rs. 300 irrespective of the market price.
To exercise this option Amit pays Vinod, a fee or premium of Rs.2 per share.
If Z Corp shares fall, below Rs.300, Amit can use the put option & sell his shares to Vinod at Rs.300 & limit his losses.
If the price rises, Amit can sell the shares at the market price & recover the premium he paid for the put option.
Put options are for traders who want to minimize their risk in a volatile market. Learn about how to trade in share/stock market.