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What is a Put?

definition

A put option is a contract that allows investors to sell shares of a security at a specific price and up until a certain time.

🤔 Understanding a put option

A put option is a contract that gives the holder the right, but not the obligation, to sell shares of a security at a specific price (called the “strike price”) and up until a certain time. Options are a financial tool that investors use to make bets on movements in the stock market. There are two primary kinds: put options and call options. Options generally represent 100 shares, meaning you can buy those shares (in the case of a call option) and sell those shares (in the case of a put option) at the strike price. If you buy a put option you believe the price of the underlying security is going to go down. If the stock's price moves below the option's strike price before the option expires, you can exercise the option and make money. If it doesn't, the put option will expire worthless and you'll lose your entire investment

example

Let’s say John buys a put option contract for 100 shares of fictional Company A with a strike price of $20. Company A’s stock starts off selling at $25. The cost of Company A’s stock declines, as John expected it to. Once the stock falls below the $20 mark, let’s say it’s at $18, John exercises his put option and sell 100 shares of Company A at the strike price of $20 — making a profit of $2 per share (not factoring in any fees).

Takeaway

Put options are kind of like selling your car to a dealership, when it offers to buy your car at a specific price…

With a put option, you bet that the value of a certain stock is going to go down. Buying a put option can give you the chance to make money off the stock’s loss. It's sort of like selling a car to a dealership that's only willing to buy your car from you at a specific price, similar to how a put option gives you the option to sell a stock at a certain price.

Tell me more...

How does a put option work?i
What are the potential benefits of buying a put option?
How could you potentially make money buying puts?
What is the difference between put and call?

How does a put option work?i

A put option has a buyer and a seller. The buyer pays the seller a premium (the price of the option). The buyer is betting that the market price of the underlying security is going to go down. The seller is betting that the market price of the stock will stay the same or go up (in which case the buyer probably won’t want to exercise their right to sell, and the seller will be left with a profit from the premium).

The buyer can choose to sell, but they don’t have to. So let’s say Steve buys a put option. Steve doesn’t have to exercise his ability to sell the shares. But if Steve does decide to sell the stocks, the seller of the option is obligated to buy them, as outlined in the put option contract.

Each put option typically covers 100 shares of the underlying stock. The individual buying the option doesn’t have to own that underlying stock.

A put option is worth money (otherwise known as being “in the money”) if the stock’s share price is lower than the strike price. Let’s say Jim buys a put option for Company A with a strike price of $10. Once the stock price drops below $10 on the market, the put option is “in the money.”

You can purchase a put option through a broker just as you might buy other types of securities. If you’re planning to buy a put option, there are a few things you’ll want to consider.

First, think about the amount of time you want the option. The life of a put can vary by many months. You should also consider what you want the strike price to be. This number primarily comes down to how far you expect the value of the stock to fall. Finally, think about how much of a premium you’re willing to pay.

What are the potential benefits of buying a put option?

Put options could be beneficial in one of two scenarios. First, they can be helpful to someone who owns a stock and fears the price might go down. In that case, they may buy a put option to help protect themselves from losses if the stock price falls lower than the strike price. In this situation, the investor still may end up losing money, but not as much as they may have without the put option.

Imagine that you own 100 stock shares of the fictional Tech Company XYZ, and it’s trading at $50 per share. You’re worried that the price might fall, so you buy a put option that lets you sell at $45 per share. That way, if the stock price drops to $40, you can sell your stock for $45 and lose only $5 per share rather than the $10 you might have lost.

The other situation in which someone might benefit from a put option is if they buy the option without already owning the underlying security. However, they think the security’s price is going to go down, and they want to profit from it.

For example, let’s say a stock is currently trading at $100. An investor thinks the price is going to drop, so they buy a put option that has a strike price of $95. Right now, the option isn’t worth any money.

But let’s say the stock plummets to $75. That investor goes out and buys 100 shares of the stock at $75, and then exercises the right from the put option to sell at $95. They’ve now instantly made a profit of $20 per share (minus the cost of the option’s premium and any other trading fees).

How could you potentially make money buying puts?

If you’re buying a put option to protect yourself from losses on a stock you currently own, your objective isn’t really to make money. You’re just trying to minimize your losses in the event that the stock price does drop.

However, some people buy put options to make money. These investors are looking to make a profit off of falling stock prices.

There can be benefits to this type of options trading. The risk is limited. The only upfront cost for you is the cost of the premium plus commissions. And worst-case scenario is that the price never drops lower than the strike price. Then the only money you’ve lost is the amount of money spent on the contract premium (plus commissions). And if the stock falls considerably, you might be looking at a profit. Still, all investments carry risk; you can never predict what a stock will do in the future.

There are certainly disadvantages to this type of trading as well. First of all, put options have an expiration date. You only benefit from the stock price falling if it happens before the put option expires. If the stock price drops the day after the option expires, you’re out of luck.

The other downside is that of the three possible scenarios (the stock price dropping, the price rising, or the price staying the same), two of the three are unprofitable for you. You lose money if the price rises. You lose money if the price stays the same. Your only profit comes if the stock price falls below the strike price.

A seller of a put believes the price of the stock will stay the same or will go up. The seller collects the premium in return for assuming the obligation to buy the shares if the option holder exercises the contract. If the seller is correct and the put option expires worthless, he or she makes a profit equal to the amount of the premium less commissions. However, if the stocks moves in the wrong direction, the seller faces substantial risk because the price of the underlying stock can fall to zero.

It’s important to note that there’s no way to know for sure if a stock price will rise or fall, which means there’s a risk to this type of investment strategy. All investing carries risk and options trading is not suitable for all investors.

What is the difference between put and call?

Just like a put option allows the owner to sell a security at a specific price, a call option allows the owner to buy a security at a particular price. But just like with a put option, they don’t have to exercise that right.

And just as someone would buy a put option if they expect the price of a stock to go down, someone would buy a call option when they expect the price of a stock to go up. Just like with a put option, the price at which they can buy is determined ahead of time. And when the price goes above the strike price, that call option is worth some money.

So when might someone purchase a call option?

Let’s say there is a stock that is currently trading at $10 per share, but an investor believes the price is going to go way up. They might buy a call option that allows them to purchase the stock at $10.

Right now, that option isn’t worth anything, because they can get the stock for the same price without the option. But then let’s say the stock price goes up to $15. They can exercise their right to buy at $10, and then immediately turn around and sell it for $15, making a profit of $5 per share (minus any fees and the premium they paid for the option).

The above examples are intended for illustrative purposes only and do not reflect the performance of any investment. Investing involves risk, which means - aka you could lose your money.

Keep in mind options trading entails significant risk and is not appropriate for all investors. Certain complex options strategies carry additional risk. To learn more about the risks associated with options trading, please review the options disclosure document entitled Characteristics and Risks of Standardized Options, available here or through https://www.theocc.com. Investors should consider their investment objectives and risks carefully before trading options. Supporting documentation for any claims, if applicable, will be furnished upon request.

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