What is a Put Option?

In investing, a Put Option is a stock market device the gives the owner of the Put the right, but not the obligation, to sell an asset (known as the underlying), at a particular price (called the Strike), at a predetermined date (the maturity or expiry). Buying a Put means that the purchaser is pessimistic about the stock and believes that its price will decrease. The only way to make money on a put as a buyer is for the price of the stock to decrease below the strike price.


Put Options

I want to go over, briefly, put options. When we think about investing, a put option is used to speculate on the future stock price without actually buying the stock. You’re speculating on whether the stock price will go up or down without actually buying the stock.

When you as an investor buy a put option, it gives you the right to sell the stock at a certain price to the put writer on a specific date. You’re projecting the future, saying, “I’m going to sell this stock without actually buying it to the writer of the put option for this amount at this date.”

By doing that, the investor is hoping, or betting on the fact, that this price and the stock will go down, resulting in a profit and the put writer, by writing it and selling it then to the investor, is betting on the price that the stock will go up.

Now, if the stock goes up in value, then when it comes due the put expires and the writer just pockets the premium then basically as profit. Basically, a put option is a speculative investment in the future without actually buying the stock.

The investor is betting on the stock price going down. The put writer is betting on it going up. The investor makes money then based on the difference between how much the stock price goes down below what the writer put it at. In the sale then he gets the difference.

The writer hopes it goes up and not because he makes money on the difference in the price, but he just pockets the premium paid to write the put. Now, when we think about calls and puts we need to remember the strike price which is the agreed upon price ahead of time.

Calls and puts can both be said to be “in the money”. This is a phrase that means that the appropriate result that you were looking for in buying the call or the put actually was achieved. A call makes money, or is considered to be in the money, when the price is above the agreed upon- the stock price goes up above.

A put is said to be in the money if the stock price then drops below the agreed upon strike price. Just because something is in the money, though, does not mean profitable. You may be in the money and yet the premium paid for this may be greater than the amount of return.

Therefore, “in the money” is not the same thing as profit. Just remember, again, to keep the basics in mind. A put option has to do with speculating on a stock’s price into the future, buying the investment from a writer, basically saying on this date you are going to buy this stock at this price, and the investor then betting on the fact that the stock price will be lower than that amount to be in the money.

The writer, being willing to write that, is speculating that it will be above that amount and, therefore, it expires. No transaction takes place, but the premium is pocketed as profit. Call wants to be above. Puts want to be below. “In the money” is good but does not always mean profitable.

Provided by: Mometrix Test Preparation

Last updated: 10/25/2018


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