A put option is a derivative contract that gives the holder the right, but not the obligation, to sell an underlying security at a specified price on or before a specified date.
What is a Put Option
There are a wide variety of uses for the purchase and sale of puts in contemporary trading. However, at its simplest a put is merely a bet on a decrease in the price of a stock that does not require the actual short selling of that stock.
Put options are considered a riskier form of speculating on a decrease in the price of a stock, as the entire value of the premium can be lost if the price of the underling stock fails to fall below a certain point. However, the potential returns from a decrease in the price of the underlying stock are similarly out-sized compared to traditional short selling.
When you are a buyer of a put option, you are speculating that the underlying asset will decrease in value within the expiration date you selected. However, if you are a seller of a put then you want the price of the underlying to stay out of the money, or above the strike price, which is a neutral to bullish position.
Put Option Breakdown
Imagine that an investor wants to sell a put option contract for 1 share of company A for $2 per share that expires in one week.
• The seller of a put is known as the ‘underwriter‘ for that contract, while the buyer of the put option is known as the ‘holder’ of that contract.
• The price that the seller of a put receives and the buyer of the put option pays is known as the contract’s ‘premium’.
• The one week duration of the put option is known as the ‘expiry date‘ of the contract.
• American style put options allow the contract holder to exercise the contract on or before the expiry date, while European style put options can only be exercised on the expiry date.
• Put s can be resold on the open market by the holder, though the underwriter remains the same.
• Puts for sale are displayed in an ‘options chain‘, which is a table detailing the various put options available according to their expiry date and strike price, and displays the current bid/ask spread for the premium or sale price of the contract.
Final Thoughts
There are a large number of reasons that investors may want to buy or sell put options on a stock or some other underlying asset or security.
Put options also often play a complementary role in larger and more complex positions, as their wide variability in terms of expiry dates and strike prices allows investors to create highly sophisticated trading positions using put options, the underlying stock or security, and other derivatives.