A put option gives the holder of the bond the right but not the obligation to redeem the bond before its maturity. It is an embedded put option bond.

On execution of the put option on a bond, bondholders get entitled to receive the principal amount invested at the par value.

However, the principle behind the put option in a bond is related to the inverse relationship between the price of the bond and the interest rates. As the value of the existing bonds declines due to the increase in the prevailing market interest rates, the investors are safeguarded by the issuers from the potential increase in the market interest rates.

For example, XYZ company issues a bond with a face value of Rs.100 with a coupon rate of 4%. The prevailing interest rate is 3% and bonds mature in the next 10 years. Bond is embedded with a put option after the first five years of the life of the bond.

After the first five years of the life of the bond the interest rates in the market increases; it does not make sense from the investors perspective to hold the bonds until maturity and hence they exercise the put option and receive the principal amount of their initial investment.

That initial investment amounts can be reinvested in the newly issued bonds in the market generating higher interest payments. This option works under the Bond swapping strategy.

The put option also helps the bondholders to exit in case there is a fall in the prices in the secondary market.

In case if the interest rate in the market does not change or declines, investors do not execute the put option and hold the bond until maturity. However, a decline in the market interest rates let the issuer exercise the call option embedded.