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

Understanding Put Option Buyers Through a Case Study

To gain a superior understanding of Put Options, let us develop a practical example. We shall start from the buyer’s perspective and then examine it from the seller’s perspective.

This is the closing chart of Bank Nifty as of a recent trading session.

Here are some observations:

Bank Nifty is trading at 51,240

It was two days ago that Bank Nifty tested its resistance level, marked by a green line, of 51,800

In my analysis, I identify the level of 51,800 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

I marked the price action area with blue rectangular boxes

Recently, 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

Therefore, given the technical impediments in combination with a void of any important catalysts, banking equities may not be favoured by the current market

Consequently, traders could be tempted to switch out of banks in favour of the current investment trend

My outlook for Bank Nifty is bearish due to the reasons provided above

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

In these conditions, considering buying a Put Option on the Bank Nifty could be a prudent decision

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 51,200 Put Option with a premium of Rs 420. The seller of this option will earn the amount whilst I have to pay it.

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

If I were to acquire Bank Nifty’s 51,200 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 examine how intrinsic value is calculated. As we discussed in the prior chapter, intrinsic value is considered to be worth what the buyer will receive 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.

For those exploring equity investment opportunities through a stock broker or consulting with a financial advisor, understanding put option intrinsic value calculations proves essential when navigating the stock market. Whether evaluating trading calls or utilising a stock screener to identify opportunities, comprehending put option mechanics enables more sophisticated bearish strategies.

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