Long Put (Bearish View): A put option gives the buyer the right to sell the underlying asset at the strike price specified in the option contract. This option is bought when there is a bearish view on the stock/index. It means that the trader is of a view that the stock/index might fall in future.
Profit and loss are calculated this way:
If upon expiration, the underlying/spot price goes below the strike price, he makes a profit equal to the difference of strike-spot price. Lower the spot price higher the profit he makes.
If the spot price of the underlying is higher than the strike price, he lets his option expire un-exercised. His loss in this case is the premium he paid for buying the option.
Let us take an example of Nifty here and draw the payoff diagram. We are considering a strike price of 8600. We then move forward and assume what if nifty expires at a price higher or lower than strike price and the profit or loss a buyer makes.
|Put Option Strike (K)||Nifty at Expiry (S)||Payoff Max((K-S,),0)||Premium||Net Payoff|
We can observe from the above table that a buyer is in profit if Nifty expires below 8600(strike price). He is in loss if Nifty expires at or above the strike price of 8600.
The maximum loss that the option buyer has incurred is the premium paid by him i.e. 50 rupees. And the profit in this case is unlimited or to the extent of the difference between (strike-spot price)
Short Put (Bullish View): A Short Put is also known as selling a Put option. A writer/Seller sells a put option if he is bullish on Nifty i.e. if he anticipates that Nifty may rise in future.
In this case a seller receives a premium upfront from the buyer. If everything goes in favour of the seller, i.e if Nifty rises in the future the maximum profit for a seller would be the premium received. Whereas if Nifty falls, the seller bears an unlimited loss.
Let us see this with an example
The seller is selling a put option with a strike price of 8600. We then move forward and assume what if nifty expires at a price higher or lower than strike price and the profit or loss a seller makes.
|Put Option Strike (K)||Nifty at Expiry (S)||Payoff = -Max((K-S),0)||Premium||Net Payoff|
As observed in the above table, if Nifty expires above the strike price the maximum profit the seller makes is the premium received i.e. 50 rupees. If nifty expires at or below the strike price, he makes a loss equal to the difference of -(strike-spot). The higher the Nifty moves, the higher is his loss.