Put Option: What It Is, How It Works, and How to Trade Them

Contrary to a long put option, a short or written put option obligates an investor to take delivery, or purchase shares, of the underlying stock at the strike price specified in the option contract. There are several factors to keep in mind when it comes to selling put options. It’s important to understand an option contract’s value and profitability when considering a trade, or else you risk the stock falling past the point of profitability. Calculate your “net price”—that’s the strike price minus the premium you collect—before entering any trade. For example, if you sell a $150 put on Advanced Micro Devices Inc (AMD) and collect $3 in premium, your net purchase price would be $147 per share if the stock falls below $150.

2 – Option seller in a nutshell

But, importantly, investors don’t have to own the underlying stock to buy a put. Some investors buy puts to place a bet that a certain stock’s price will decline because put options provide higher potential profit than shorting a stock outright. Even with the reduced risk, most traders don’t exercise the put option.

2 – Building a case for a Put Option buyer

The option buyer can sell their option and either minimize loss or realize a profit, depending on how the price of the option has changed since they bought it. When you buy a call, you gain the right but not the obligation to buy shares at a set price (called the strike price) within a specific time frame. You’re essentially reserving the right to buy shares at today’s prices, even if they go up tomorrow.

The Basics of Put Options

A naked put, also called an uncovered put, is a put option whose writer (the seller) does not have a position in the underlying stock or other instrument. This strategy is best used by investors who want to accumulate a position in the underlying stock, but only if the price is low enough. That allows the exerciser (buyer) to profit from the difference between the stock’s market price and the option’s strike price. As the spot price of the underlying asset exceeds the strike price, the writer of the option incurs a loss accordingly (equal to the option buyer‘s profit).

For covered calls, you won’t lose cash—but you could be forced to sell the buyer a very valuable security for much less than its current worth. That’s when you don’t already own the security (or enough of the security) to sell the buyer if he or she chooses to exercise the call. You execute the option and pay $4,500 for shares of XYZ worth $5,000, which you can keep or turn around and sell on the open market. When you buy an option, you’re the one who will decide if you want to “exercise” the option sometime before the expiration date.

But this compensation does not influence the information we publish, or the reviews that you see on this site. We do not include the universe of companies or financial offers that may be available to you. From ETFs and mutual funds to stocks and bonds, find all the investments you’re looking for, all in one place.

Some brokers have specialized features and benefits for options traders. For those who have an interest in options trading, there are many brokers that specialize in options trading. It’s important to identify a broker that is a good match for your investment needs. Call and put options are important derivative instruments through which traders and investors try to make additional profits or recover losses.

The investor could collect a premium of $3.45 per share (× 100 shares, or $345) by writing one put option on SPY with a strike price of $430. Assume an investor buys one put option on the SPDR S&P 500 ETF (SPY), which was trading at $445 (January 2022), with a strike price of $425 expiring in one month. For this option, they paid a premium of $2.80, or $280 ($2.80 × 100 shares or units). However, success requires more than just chasing the highest premium—you must be financially and mentally prepared to take ownership of shares if they fall below your strike price.

Thus, his net profit, excluding transaction costs, is $850 ($1,000 – $150). That’s a very nice return on investment (ROI) for just a $150 investment. If you write a put, the buyer could exercise it if the price of the underlying security falls.

Value Added Services

Each contract represents 100 shares, so for every $1 decrease in the stock below the strike price, the option’s cost to the seller increases by $100. The break-even point occurs at $45 per share, or the strike price minus the premium received. The put seller’s maximum profit is capped at $5 premium per share, or $500 total.

1. The option buyer’s loss is, again, limited to the premium paid for the option.
2. A call option provides the holder with the right, but not the obligation, to buy a stock at a predetermined price within a specified period.
3. Trusted by 50 million+ customers in India, Bajaj Finserv App is a one-stop solution for all your financial needs and goals.
4. Both options are used to speculate on price movements or hedge existing positions.
5. This strategy is used as a form of investment insurance to ensure that losses in the underlying asset do not exceed a certain amount, namely the strike price.

Speculation – Buy calls or sell puts

1. That’s when you don’t already own the security (or enough of the security) to sell the buyer if he or she chooses to exercise the call.
2. A put is an options contract that gives the owner the right, but not the obligation, to sell a certain amount of the underlying asset, at a set price within a specific time.
3. When you sell a put option, you agree to buy a stock at an agreed-upon price.
4. He paid $2,500 for the 100 shares ($25 x 100) and sells the shares for $3,500 ($35 x 100).
5. When you write an option, you’re the person on the other end of the transaction.

That is, the buyer wants put meaning in share market the value of the put option to increase by a decline in the price of the underlying asset below the strike price. The writer (seller) of a put is long on the underlying asset and short on the put option itself. That is, the seller wants the option to become worthless by an increase in the price of the underlying asset above the strike price. Generally, a put option that is purchased is referred to as a long put and a put option that is sold is referred to as a short put. An example of a put option involves an investor purchasing a put option for shares of ABC Ltd. at Rs. 500 per share, expiring in two months. If ABC’s stock price falls to Rs. 450, the investor can exercise the put option, selling shares at the higher Rs. 500 strike price.

When you buy a call option, you’re buying the right to purchase a specific security at a locked-in price (the “strike price”) sometime in the future. Volatility is one of the main determinants of option price so write puts with caution in volatile markets. You might receive higher premiums because of greater volatility but your put may increase in price if volatility continues to trend higher. Options are derivatives, financial instruments that derive their value from their underlying asset.

If exercising it will cause you to lose money, you can simply let it expire. That way, the only money you’ll lose is what you spent on the option itself. The two main reasons to write a put are to earn premium income and to buy a desired stock at a price below the current market price. Markets that move sideways (trading within a consistent price range) can be ideal for put selling. During these periods, you should work to identify clear support levels—prices where stocks have previously stopped falling before bouncing higher. An investor can enter a call options contract as a seller without possessing the underlying asset.