An options contract that gives the buyer the right, but not the obligation, to sell the underlying security at a specified price and at a predetermined date
Over 2 million + professionals use CFI to learn accounting, financial analysis, modeling and more. Unlock the essentials of corporate finance with our free resources and get an exclusive sneak peek at the first module of each course. Start Free
What is a Put Option?
A put option is an option contract that gives the buyer the right, but not the obligation, to sell the underlying security at a specified price (also known as strike price) before or at a predetermined expiration date. It is one of the two main types of options, the other type being a call option.
Put options are traded on various underlying assets such as stocks, currencies, and commodities. They protect against the decline in the price of such assets below a specific price.
With stocks, each put contract represents 100 shares of the underlying security. Investors do not need to own the underlying asset for them to purchase or sell puts. The buyer of the put has the right, but not the obligation, to sell the asset at a specified price, within a specified time frame.
The seller has the obligation to purchase the asset at the strike/offer price if the option owner exercises their put option.
Buying a Put Option
Investors buy put options as a type of insurance to protect other investments. They may buy enough puts to cover their holdings of the underlying asset. Then, if there is a depreciation in the price of the underlying asset, the investor can sell their holdings at the strike price. Put buyers make a profit by essentially holding a short-selling position.
The owner of a put option profits when the stock price declines below the strike price before the expiration period. The put buyer can exercise the option at the strike price within the specified expiration period.
They exercise their option by selling the underlying stock to the put seller at the specified strike price. This means that the buyer will sell the stock at an above-the-market price, which earns the buyer a profit.
Example
Assume that the stock of ABC Company is currently trading at $50. Put contracts with a strike price of $50 are being sold at $3 and have an expiry period of six months. In total, one put costs $300 (since one put represents 100 shares of ABC Company).
Assume that John buys one put option at $300 for 100 shares of the company, with the expectation that the ABC’s stock price will decline. The stock price is expected to fall to $40 by the time the (put) option expires.
If the price does drop to $40, John can exercise his put option to sell the stock at $50 and earn 100 shares times $10 – $1,000. His net profit is $700 ($1000 – $300 option price]. However, if the stock price remains above the strike price, the (put) option will expire worthless. John’s loss from the investment will be capped at the price paid for the put.
Selling a Put Option
Instead of buying options, investors can also engage in the business of selling the options for a profit. Put sellers sell options with the hope that they lose value so that they can benefit from the premiums received for the option.
Once puts have been sold to a buyer, the seller has the obligation to buy the underlying stock or asset at the strike price if the option is exercised. The stock price must remain the same or increase above the strike price for the put seller to make a profit.
If the price of the underlying stock falls below the strike price before the expiration date, the buyer stands to make a profit on the sale. The buyer has the right to sell the puts, while the seller has the obligation and must buy the puts at the specified strike price. However, if the puts remain at the same price or above the strike price, the buyer stands to make a loss.
More Resources
Thank you for reading CFI’s guide on Put Option. To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below:
FAQs
A put option gives you the right, but not the obligation, to sell a stock at a specific price (known as the strike price) by a specific time — at the option's expiration. For this right, the put buyer pays the seller a sum of money called a premium.
How does a put option make money? ›
Put buyers make a profit by essentially holding a short-selling position. The owner of a put option profits when the stock price declines below the strike price before the expiration period. The put buyer can exercise the option at the strike price within the specified expiration period.
What is a put vs call? ›
A call option gives a trader the right to buy the asset, while a put option gives traders the right to sell the underlying asset. Traders would sell a put option if they are bullish on the asset's price and sell a call option if they are bearish on the price.
What is a real example of a put option? ›
An investor purchases one put option contract on ABC company for $100. Each option contract covers 100 shares. The exercise price of the shares is $10, and the current ABC share price is $12. This put option contract has given the investor the right, but not the obligation, to sell 100 shares of ABC at $10.
Why would someone buy a put option? ›
Investors may buy put options when they are concerned that the stock market will fall. That's because a put—which grants the right to sell an underlying asset at a fixed price through a predetermined time frame—will typically increase in value when the price of its underlying asset goes down.
What is the downside of buying a put option? ›
Put options lose value as the underlying asset increases in price, as volatility of the underlying asset price decreases, as interest rates rise, and as the time to expiration nears.
Who benefits from a put option? ›
Investors use put options to achieve better buy prices on their stocks. They can sell puts on a stock that they'd like to own but that is too expensive currently. If the price falls below the put's strike, then they can buy the stock and take the premium as a discount on their purchase.
Are puts riskier than calls? ›
Call options and put options essentially come with the same degree of risk. Depending on which "side" of the contract the investor is on, risk can range from a small prepaid amount of the premium to unlimited losses. Investors who know how each work helps determine the risk of an option position.
How much money can you lose on a put? ›
As a Put Buyer, your maximum loss is the premium already paid for buying the put option. To reach breakeven point, the price of the option should decrease to cover the strike price minus the premium already paid.
Is put buy or sell? ›
A put option gives you the right, but not the obligation, to sell a stock at a specific price (known as the strike price) by a specific time — at the option's expiration. For this right, the put buyer pays the seller a sum of money called a premium.
The absolute worst-case scenario for a put sale is that you are forced to buy a stock whose market price goes to zero, in which case you'll never be able to re-sell it at all, and you'll have to accept the complete loss of the money you paid to buy it at the strike price.
Can you buy a put option without owning stock? ›
No you don't need to own the stock to buy a put, but you will need to pay the premium paid for the put on settlement date T+1. If you do not hold the stock however, you will need to sell the put prior to expiration. If the stock is below the strike price you will receive something for your option (intrinsic value).
Why is my put option losing money when the stock is going down? ›
Selling put options can be risky since put sellers must buy the underlying asset at the strike price. This can result in significant losses if the the price of the stock were to fall below the strike price.
How do puts make money? ›
As a long put holder, you can either sell the contact before expiry for a profit if there is a swift bearish movement in the stock price. On the other hand, short put positions make money when the contract expires OTM and worthless – the premium received for selling the contract up front is the profit.
Who owns the stock in a put option? ›
A put option is a contract that gives its holder the right to sell a set number of equity shares at a set price, called the strike price, before a certain expiration date. If the option is exercised, the writer of the option contract is obligated to purchase the shares from the option holder.
What happens if I don't sell my put option? ›
Q. What will happen if an option holder does not exercise their right to sell before its expiration? If the option's strike price has not been reached by its expiration date, your brokerage will automatically close the deal and remove the option from your list of open positions.
How profit is calculated in put option? ›
The break-even price of a call is the strike plus the premium (plus any commissions), and the break-even price of a put is the strike minus the premium (and any commissions). The profit earned by the option holder equals the difference between the market price and the break-even price.
How do options make so much money? ›
An option buyer can make a substantial return on investment if the option trade works out. This is because a stock price can move significantly beyond the strike price. For this reason, option buyers often have greater (even unlimited) profit potential.
How does the put option work with an example? ›
A put option allows the holder to sell an asset at a specified price before a specified date. An example would be to purchase a Rs. 100 put option on Stock X. The stock can be sold if its price falls below Rs.
