Put Option

Written By:
Paul Tracy
Updated October 7, 2020

What is a Put Option?

A put option is a financial contract between the buyer and seller of a securities option allowing the buyer to force the seller (or the writer of the option contract) to buy the security.

How does a Put Option work?

In options trading, a buyer may purchase a short position (i.e. the expectation that the price will go down) on a security. This position gives the buyer the right to sell the underlying security at an agreed-upon price (i.e. the strike price) by a certain date. If the market price falls below the strike price, as expected, the buyer can decide to exercise his or her right to sell at that price and the writer of the option contract has the obligation to buy the security at the strike price. With the exercise of the put, the trader makes the difference between the cost of the security in the market (i.e. a lower price than the option strike price) and the sale of the option to the put writer (i.e. at the strike price). 

For example, if a trader purchases a put option contract for Company XYZ for $1 (i.e. $01/share for a 100 share contract) with a strike price of $10 per share, the trader can sell the shares at $10 before the end of the option period.  If Company XYZ's share price drops to $8 per share, the trader can buy the shares on the open market and sell the put option at $10 per share (the strike price on the put option contract).  Taking into account the put option contract price of $.01/share, the trader will earn a profit of $1.99 per share.

Why do Put Options matter?

Investors will often purchase a put option on shares they already own to act as a hedge against the decline in the share price. Puts and calls are the key types of options trading.