What exactly is a Put Option?
A put option (or “put”) is a contract that gives the purchaser of the option the right, but not the obligation, to sell–or sell short–a specific amount of an underlying asset at a defined price over a certain span of time. The striking price is the preset price at which the buyer of the put option can sell the underlying asset.
Put options are exchanged on a wide range of underlying securities, such as equities, commodities, stocks, commodity markets, futures, and indices. A put option differs from a call option in that the holder has the right to purchase the underlying at a predetermined price on or before the option contract’s expiry date.
Important key points
- Put options offer option owners the right, but not the duty, to sell a predetermined quantity of underlying securities at a predetermined price within a predetermined time frame.
- Put options can be purchased on a variety of assets, including stocks, indices, commodity markets, and cryptocurrencies.
- Variations in the underlying asset’s value, the option strike price, time decay, rate of interest, and fluctuations all have an influence on put option pricing.
- Put options gain value when the underlying commodity’s prices decrease, fluctuation of the underlying asset price rises, and rates of interest fall.
- They lose their value when the underlying asset’s price rises, the uncertainty of the underlying asset’s price reduces, interest rates go up, and the expiry date approaches.
How a put Option work?
The value of the put option decreases as the price of the original stock or asset decreases. When the price of the underlying stock increases, a put option, on either end, drops in value. As a result, they are generally employed for hedging or speculating on price movement to the negative.
Put options are frequently employed in a risk-management technique known as a protective put, which is a type of investment insurance or hedge that ensures that deficits in the underlying asset should not surpass a specific amount. The investor uses this approach to hedge downside risk in a stock held in the portfolio by purchasing a put option. The trader would sell the shares at the put’s strike price if and when the option is executed. If the trader does not own the underlying stock but executes a put option, the stock will become short.
Put Option example
Let’s assume you’ve done some research and determined that the stock of XYZ Business would go below $100 per share, which is where our hypothetical company is presently trading. You now have the right to sell 100 shares at $100 a share after purchasing a put option for $5.
You may execute the option and sell 100 shares at $100 per share if the XYZ company’s stock falls below $80, resulting in a significant gain of $1,500. Divided by 100 shares, this is the $20 profit less the $5 premium paid for the option.
If you don’t possess 100 shares of the company, you can sell the option contract to another bidder; this is known as options trading.