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C. Raja Rajeshwari

IF you have a bullish view on a stock, there are two ways to cash in on the uptrend. You can either buy calls or write puts (selling the put). By selling a put, the writer has the obligation to purchase the stock at the strike price. If the put buyer exercises his right to sell, then the put holder has to buy the shares.

On writing a put, you can pocket the put premium. This strategy is normally practiced on `neutral to bullish sentiments' about the stock. The put would expire worthless if the stock price increases subsequent to the option writing, the investor keeps the premium.

However, if the stock price declines, the put writer has to pay the difference between the strike price and market price. This is the risk attached with this strategy. In addition, since you are the seller you have to maintain margin.

Let's illustrate with an example.

You write one contract of 200-lot size in Wipro. Assume that you choose the 900-strike May put. The premium you receive is Rs 1800 (200 * Rs 9). The put is deep out-of-the-money as the spot Wipro is quoting at Rs 941. The option has nine trading days to expire. The stock options traded in NSE are `American' and the put holder can exercise his right to sell anytime before expiry.

If the stock remains range-bound or appreciates until expiry then your profits are limited to the premium received - Rs 1,800.

Suppose the stock declines any day before the expiry say to Rs 890, then the put turns out-of-the-money for the put writer (the put is in-the-money for the put holder)

** The put holder can exercise the call at the in-the-money strike prices.

** The loss to the put writer would be the difference between the strike price and the market price. Thus, you would shell out the difference of Rs 2,000 (200* (900-890)).

** The net payoff would be Premium received - (strike price - market price) which would be a loss of Rs 200 (1,800-2,000) from this Wipro short put.

** The chart below shows that the put seller is in a `no loss no gain' position at Rs 891. Thus, we see that the investor is exposed to increasing losses as the price of the stock falls below Rs 891.

The difference between buying a call and that of writing put is the payoff position. In case of call buyer his payoff would be limited losses to the amount of premium paid and unlimited profits, the difference between market price and strike price. For a put seller the payoff would be `limited profits and unlimited losses'. The premium received would be the profits. Losses would be unlimited because theoretically, any stock can fall to a value of zero. Thus, in our example, the worst-case scenario would be a loss of Rs 1,78,200 (900*200 - 1,800).

In case of physical settlement as in the case of some foreign exchanges, put seller faces the possibility of buying the shares when the stock price falls below the strike price.

Note: this strategy is best practiced in neutral-to-bullish stock sentiments. Due to the risks involved, put writing is often used in combination with other options contracts.

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