What is a Put Option?

//What is a Put Option?
What is a Put Option? 2017-10-09T07:52:57+00:00

Definition: A put option is an option agreement where a buyer has the right to sell a specified quantity of the shares or securities at the strike price at maturity. Usually, investors buy a put option as a hedging strategy against a stock price decrease.

What Does Put Option Mean?

What is the definition of put option? A put option does not oblige the buyer to sell the option at maturity. If the investor is bearish on a particular stock, he can buy a put option to make a profit from the fall of market price before maturity. In fact, an investor can buy a short-term put option with the expectation that the price will fall and that he will be able to sell the security at the strike price in order to make a profit.

If the market price is lower than the strike price at maturity, the investor can decide whether he will sell his option or not, but the seller is obliged to buy the security at the strike price.

Let’s look at an example.

Example

Liam is a trader at Beverly Securities. He purchases a put option for a technology company for $2 per share, so he puts $200 as each option contract covering 100 shares. The strike price is $8 per share, and Liam can sell the shares before maturity for $8.

Liam speculates that the stock price of the technology stock will fall to $6.5. In this case, he can buy the company’s shares in the open market for $6.5 and sell them at a strike price of $8. If the stock price drops to $6.5, Liam will exercise his put option, and he will earn a profit of (100 x $8) – (100 x $6.5) = $150.

Liam thinks that the share price of the technology stock will decline, so he buys the put to hedge against the price decline. So, Liam buys a long put, expecting the price to fall. On the other hand, if Liam thought the price would rise, he would sell his put option. So, Liam would buy a short put, expecting the price to rise.

Definition Summary

Define Put Option: A put option is an investment contract that allows the owner to purchase sell securities at a specified strike price when it matures.