What is a Put Option?
A put option is a financial contract that gives the buyer the right, but not the obligation, to sell a specific underlying asset (like a stock) at a predetermined price (strike price) within a specified time period (until expiration).
Put options are bearish instruments - they increase in value when the underlying asset's price falls below the strike price. Traders use puts for speculation on price declines, hedging existing positions, or generating income through premium collection.
How Put Options Work
Key Components
Contract Elements
- • Underlying Asset: Stock, ETF, or index
- • Strike Price: Price at which you can sell
- • Expiration Date: When contract expires
- • Premium: Cost to buy the option
Rights and Obligations
- • Buyer: Right to sell at strike price
- • Seller: Obligation to buy if exercised
- • Exercise: Can happen anytime before expiry
- • Assignment: Seller must fulfill obligation
Put Option Example
Trade Setup:
- • Stock: XYZ Corp trading at $100
- • Buy 1 Put Contract (100 shares)
- • Strike Price: $95
- • Expiration: 30 days
- • Premium Paid: $2.00 per share ($200 total)
Possible Outcomes:
- • Stock falls to $90 → Profit: $300
- • Stock stays at $100 → Loss: $200
- • Stock rises to $110 → Loss: $200
- • Breakeven: $93 (Strike - Premium)
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Common Put Option Strategies
Long Put (Buying Puts)
Strategy Overview:
- • Market Outlook: Bearish
- • Maximum Risk: Premium paid
- • Maximum Reward: Strike price - premium
- • Breakeven: Strike - premium paid
When to Use:
- • Expect significant price decline
- • Limited capital but want leverage
- • Want defined risk exposure
- • Hedging long stock positions
Protective Put
Strategy Overview:
- • Position: Own stock + buy put
- • Purpose: Downside protection
- • Cost: Put premium paid
- • Benefit: Limited downside risk
Example:
- • Own 100 shares at $50
- • Buy $45 put for $1.50
- • Maximum loss: $6.50 per share
- • Acts like insurance policy
Cash-Secured Put
Strategy Overview:
- • Action: Sell put option
- • Cash Requirement: 100% of strike value
- • Income: Collect premium
- • Risk: May have to buy stock
When to Use:
- • Want to own stock at lower price
- • Generate income from cash
- • Neutral to bullish outlook
- • Comfortable owning the stock
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Put Option Pricing Factors
Intrinsic vs. Time Value
Intrinsic Value
- • Value if exercised immediately
- • Strike price - current stock price
- • Cannot be less than zero
- • "In-the-money" amount
Time Value
- • Premium above intrinsic value
- • Decreases as expiration approaches
- • Higher for longer-dated options
- • Affected by volatility
The Greeks for Puts
Delta & Gamma
- • Delta: Negative for puts (-0.5 typical)
- • Put gains $0.50 when stock falls $1
- • Gamma: Rate of delta change
- • Higher gamma = more sensitivity
Theta & Vega
- • Theta: Time decay (negative)
- • Put loses value as time passes
- • Vega: Volatility sensitivity
- • Higher volatility = higher put value
Advantages vs. Risks
Advantages
Limited Risk
Maximum loss is premium paid
Leverage
Control 100 shares with smaller capital
Portfolio Protection
Hedge against stock declines
No Margin Required
When buying puts outright
Risks
Time Decay
Options lose value as expiration approaches
Total Loss Possible
Can lose entire premium if wrong
Complexity
Requires understanding of multiple factors
Volatility Risk
Declining volatility hurts put values
Put Option Best Practices
Selection Criteria
Strike Price Selection
- • Out-of-money: Lower cost, higher risk
- • At-the-money: Balanced risk/reward
- • In-the-money: Higher cost, lower risk
- • Consider your market outlook
Time to Expiration
- • More time = Higher premium
- • 30-45 days often optimal
- • Avoid weekly options unless experienced
- • Match timeframe to outlook
Risk Management
Position Sizing
- • Never risk more than you can afford to lose
- • Start with small positions when learning
- • Consider options as percentage of portfolio
- • Don't put all capital in one expiration
Exit Strategies
- • Set profit targets (50-100% gains)
- • Cut losses at 50% of premium
- • Don't hold to expiration unless ITM
- • Roll options if thesis still valid
Key Takeaways
Bearish Instrument: Put options profit when the underlying asset price falls below the strike price.
Limited Risk: Maximum loss for put buyers is the premium paid for the contract.
Multiple Uses: Speculation, hedging, and income generation through various put strategies.
Time Sensitivity: Options are wasting assets that lose value as expiration approaches.
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Related Trading Concepts
Call Option
Bullish options contract giving the right to buy at a specific price.
Options Greeks
Risk sensitivities that measure how option prices change.
Implied Volatility
Market's expectation of future price volatility embedded in option prices.
Strike Price
The predetermined price at which options can be exercised.
Time Decay
The erosion of option value as expiration approaches.
Hedging
Risk management strategy to offset potential losses in investments.
Options Trading Risk Disclaimer
Options trading involves substantial risk of loss and is not suitable for all investors. Options can expire worthless, resulting in total loss of premium paid. Past performance does not guarantee future results. The complexity of options strategies requires thorough understanding before trading. Never invest more than you can afford to lose and consider consulting with qualified financial professionals before implementing any options strategy.