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Put Options

Put options (or “puts”) give you the right, but not the obligation, to sell an underlying security at a specific price for a fixed period of time. When traders believe an underlying security (e.g., a particular stock or an index) will fall in price, they may buy puts. They must sell an underlying stock before the option expires on a predetermined expiration date, if they wish to sell the security. The premium paid for the option, is the financial risk of buying a put. The premium will be lost (assuming the put option was not sold to another trader prior to expiration), if the option expires worthless. The put buyer can make a profit, if the price of the underlying stock or index moves lower, that is to say, below the strike price.

If you own a put options you can:

• You can let the option expire worthless.
  
• You can exercise your right to short the market.
  
• You can sell put options.

Up until a specified expiration date, a put seller, also called the “writer”, takes on the obligation of buying an underlying security from the put buyer at a predetermined strike price. By collecting option premium from put buyers, this is how the sellers make money. The put writer keeps the premium if a put expires worthless (i.e., if the put buyer can not exercise the put option at a profit).

A simple example illustrates how puts may be used:

Let’s assume that current price of a particular stock is $40. Also assume that you buy a put, which give you the right, but not the obligation, to sell the underlying stock to the put writer at a strike price of $36. As long as the put has not yet expired, you have the right to sell the stock at that price, say for three months from today. You paid a premium of $1 per contract (i.e., per 100 shares of the underlying stock), for acquiring this right.

You may choose to exercise your put option, if after some time the stock has declined to $30. The put seller must buy your stock for $36. (You could at this point buy it back for $30, pocketing the difference as your profit). By investing $1 you are making $6 (600%), in this case.

If the stock moves up instead of down, on the other hand, say to $45, your put will expire worthless. You lose the premium you paid for the option while the put seller keeps the premium he or she received from you, in this case.

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