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Put options are financial instruments that allow investors to trade options to sell 100 shares of a particular stock at some point in the future. Giving investors this option allows them to take a positive or negative position in a stock at a relatively low price. In addition, put options are good hedging instruments against other stock positions. The downside of a put option is that if the price of the underlying security moves in the opposite direction from where the investor expects it to go, there could be a substantial loss.
Put options are one of the two main types of options traded by investors. Call options allow investors to buy shares at some point in the future, while put options give them the right, but not the obligation, to sell shares of the underlying stock. The option can only be exercised if the share price reaches a level known as the exercise price, which is defined in the option contract. Also stipulated in the contract is the premium, which is the price paid by the option buyer for the contract, and the expiration date, when the contract loses value.
The main advantage of buying puts is that they give investors the opportunity to speculate on securities that they believe may be headed for a price decline. For example, suppose an investor buys a put option on 100 shares at the strike price of $20 US dollars (USD) per share. If the price falls to $10 per share, the option holder can exercise the option, buy the shares at $10 per share, and then sell them to the option seller at $20 per share, pocketing the difference for a good profit.
It is important to realize that put options can be bought or put, which means that investors can take positions depending on the direction they think the price of the underlying stock will take. Also, buying a put option is a good way for investors to protect themselves. An investor with a lot of holdings in a particular stock may want to buy a put option to protect against that stock’s price falling.
As with any investment opportunity, put options can cause damage if the price falls in the opposite direction of what the investor expects. This can be especially damaging to the person selling these options. While option buyers only risk the premium paid for the option, option sellers or writers can suffer unlimited losses.