We understood previously that an option seller and buyer were like two sides to the same coin. They may have an opposing view of markets. This means that if the buyer of a put option is negative about the market, the seller must be bullish. Remember that we reviewed the Bank Nifty chart in Chapter 1. We will now review it from the viewpoint of a seller of put options.
This is the typical thinking process of the Put Option Seller.
This stage may pose a problem for you: If the outlook is bullish why sell a put option when you can just buy a option?
The attractiveness of the premiums will determine whether you decide to buy or sell a call option. If the premium for the call option is low, then it makes sense to buy a call option. However, if the premium for the put option trades at a high premium, then selling the option and collecting the premium makes sense. The attractiveness of the premium will determine what you do. To know how to decide whether to buy a call option, or sell a put option, you must have some knowledge about 'option pricing'. We will be covering option pricing in the next module.
These thoughts are what we will use to assume that the trader writes (sells) the 18400 Put Option and receives Rs.315 in premium. Let's look at the P&L of a seller of Put Option and make some generalizations.
Please note that margins in your account are blocked when you write options, regardless of whether they are Calls or Puts. This perspective has been discussed here. You are invited for the same.
Remember that the calculation of the intrinsic price of an option is the same whether you write a put or buy a put option. The P&L calculation is different, as we'll discuss in detail. Let's assume that the expiry date is different from what actually happens and then see how the P&L reacts.
Given that you have done so for the previous 3 chapters, I assume that you should be able to quickly generalize the P&L behavior at expiry. These generalizations can be found below (be sure to pay attention to row 8, which is the strike price for this trade).
Premium Received - [Max (0. Strike Price – Spot Price)
Let's take 2 random numbers and see if this formula works.
= 315 - Max (0.18400 -16510)
= 315 -1890
@19660 Position must be profitable and not restricted to premium payments
= 315 – Max (0, 18400-6600)
= 315 - Max (0. -1260).
Both the expected and actual results are evident.
The breakdown point for a Put Option Seller can also be described as the point at which he starts to lose money after giving away all his premium.
Strike price - premium received
The breakdown point for the Bank Nifty would be
= 18400 - 315.
According to this breakdown point definition, at 18085, the put option seller shouldn't make or lose any money. This also means that he will lose all of the Premium he has earned. Let's use the P&L formula to calculate the P&L at breakpoint.
= 315 – Max (0, 18400-18085)
= 315 - Max (0. 315)
= 315 - 315.
The obtained result is in accordance with the expectations of the breakdown point.
We can see the generalizations that we made about the P&L of the seller of put options if we connect them (as shown in the table).
These are some things you should take into consideration from the chart. Remember that 18400 is the strike rate.
These points should help you understand the basics of selling Put Option. In the previous chapters, we looked at the call option as well as the put option from both buyers and sellers perspectives. We will summarize these concepts quickly and then shift to other important concepts about Options in the next chapter.