put option example: Analysis of Bank Nifty and the Bearish Outlook

Understanding Put Option buyer with a case study 

To get a better understanding of Put Options, let us develop a practical example. We will start from the buyer’s perspective and then look at it from the seller’s perspective.

This is the closing chart of Bank Nifty as of 8th April 2015.

Here are some observations: 

1. Bank Nifty is trading at 18417
2. It was two days ago that Bank Nifty tested its resistance level, marked by a green line, of 18550.
3. In my analysis, I identify the level of 18550 as a resistance zone due to the presence of a well-defined price action area at this level, which has occurred over a significant period of time. For those who are unfamiliar with the concept of resistance, I suggest exploring further information on it here.
4. I marked the price action area with blue rectangular boxes.
5. Yesterday, the RBI chose to keep its key central bank rates unchanged, a decision that’s not surprising given Bank Nifty’s dependence on the RBI’s monetary policy.
6. Therefore, given the technical impediments in combination with a void of any important catalysts, banking stocks may not be favored by the current market.
7. Consequently, traders could be tempted to switch out of banks in favour of the current investment trend.
8. My outlook for Bank Nifty is bearish due to the reasons provided above.
9. Although engaging in futures shorting is somewhat dangerous considering the optimism of the stock market as a whole, it is only the banking sector that has been lagging behind.
10. In these conditions considering buying a Put Option on the banking Nifty could be a prudent decision.
11. When you purchase a put option, you can reap the rewards when the underlying asset decreases in value.

Given my sound reasoning, I opt to buy the 18400 Put Option with a premium of Rs.315/-. The seller of this option will earn the amount while I have to pay it.

Buying a Put option is easy. The quickest way to do it is by calling your broker and having them purchase the option of the desired stock and strike rate. Completing this in only a few seconds, it can also be done by yourself through a trading terminal though we will go more into detail about that process later on.

If I were to acquire Bank Nifty’s 18600 Put Option, it would be interesting to observe the profit and loss (P&L) of the option when it reaches its expiration. This analysis would provide valuable insights into the dynamics of a Put option’s P&L.

– Understanding Intrinsic Value (IV) of a Put Option

Before moving on to generalising the performance of Put Options, let’s take a look at how intrinsic value is calculated. As we discussed in the prior chapter, intrinsic value is considered to be worth what the buyer will get if they exercise their option upon expiry.

To better understand the difference, let’s examine the formula for calculating the intrinsic value of a Put option. Unlike a Call option, the intrinsic value of a Put option is determined by a different equation.

Spot Price – Strike Price= Intrinsic Value (IV) (Call option) 

This is the value for put option: 

Strike Price – Spot Price= Intrinsic Value (IV) (Put option) 

Please note the following timeline when considering the intrinsic value of an option:

We have just seen the formula to calculate an option’s intrinsic value upon expiry. During the series, however, the calculation is different. We’ll review how to find and use this value at expiry time, but for now let us keep it to just that.