What is a Put Option? Learn How to Buy & Sell

Puts and calls. Very simply, a call is the right to buy, a put is the right to sell.

Jim Gillies, Motley Fool Canada analyst (Source)

Every option position is composed of a put and/or call in some ratio. Here is how these fundamental options investing tools operate.

The massive number of positions that are available to investors who want to start using options may seem overwhelming. Puts and calls, however, are the same two elements that make up all options strategies. Let’s break things down, so a beginner can grasp the topic.

Exactly What is a Put Option?

Put option contracts (or just “puts”) grant holders the contractual power, but not the contractual obligation, to sell a set quantity of an asset at a fixed price within a given time period. That set price is called the strike price.

If you were to buy a call option on Apple striking at a £120 expiring in July, then that gives you the right to buy Apple for a £120 up till July 16th at market close. . The following Monday, you're out of luck…

Gillies, Motley Fool

You’re able to, er put puts on a variety of assets:

• Stocks & bonds
• Forex
• Commodities
• Indices
• Futures
• And more

By comparison, call options grant you the right to purchase the relevant asset at a predetermined price on/before the contract's expiry. For stocks, each contract represents 100 shares. 

Make sense? ★ Learn more about Call Options…  

How Do Put Options Work?

Put options may be applied for speculating or offsetting. In terms of the practicalities, they operate as follows: A put's value rises as the asset’s spot price drops, and vice versa, a put's value falls as the asset’s fundamental market value goes up. It rises in value in the sense that it’s “saving you money from losses”.

You gamble or hedge that the cost of the underlying asset will fall over the term of the contract when you purchase a put option. 

It's basically buy and sell. Call, put.

Gillies, Motley Fool

Explanation 💡: You might be wondering: why wouldn’t someone sell an asset once its price increases? Sure, but because you haven’t yet exercised your option to sell, you want to time things so that you’re protected against the asset dipping. In this way, options contracts mean you retain the right to sell at a certain benchmark price, even if the asset radially drops in price — up until the strike point. For this hedging-to-risk ratio capability, traders pay a premium. 

It’s all in the name: Options, i.e. ambivalence, ambiguousness, either-or. 

Simple Example of a Successful Put 

Exactly what is a put option? It’s hard to understand as a beginner without a simple explanation. Options experts tend to start off at a dead run. So here is an easy illustration to follow below:

Alex buys an Audi Car Company put option for £10 in total. This offers him the ability to sell 100 shares of Audi at £10 prior to the expiry date because each option contract is equal to a hundred shares.

In the event that Alex already owns 100 Audi shares, his brokerage will sell them at the £10 strike price. An option writer must buy the shares at that value in order to execute the transaction.

If Audi stock drops below that strike price, Alex will benefit from the option. In other words, Alex is guarded against the stock price dropping below the £10 put option's strike price.

However, the amount Alex paid (the premium) for the contract also affects the final profit. In other words, the breakeven threshold will be £7 per share (£10 minus £3) if Ford's share price dropped to £10 but Alex spent £3 per share for the contract. Prior to expiration, if Audi’s share price dropped to below £7, Alex would still be in the black.

Now suppose the share price drops to £5. Alex would indeed be able to sell 100 shares for £10 as opposed to the fiver going rate.

By purchasing the contract, Alex was able to sell 100 shares for £10 each, for a total of £1,000, as opposed to having to make the sale for £5 each, for a total of £500. This saved Alex £500 (minus the price of the contract and exercising it).

Max might have avoided purchasing a put option by selling his shares at £10. But it's possible that he thought the stock price could well have increased. Although he didn't want to sell the shares, he did want to be covered in the event that its value declined. He was prepared to pay the option premium in exchange for that safety.

Note: selling an option can be cheaper than exercising it, based on fees. Options exist for all kinds of financial products, even cryptocurrencies, which obviously fluctuate in price as a constant. 

Glimpse: 📘 Bitcoin Price History (2009-2022)   

Final Thoughts 

…both speculative and hedging technique traders might benefit from them.

Even if the current price for the asset has dropped, put options contracts nevertheless allow the holder to sell it at a fixed price. As a result, both speculative and hedging technique traders might benefit from them. Puts are one of the most basic derivative contracts, together with call options.

Related Guides: 

• 6 Options Strategies for Beginners
• 7 Covered Call Tips
• 10 Best Options Trading Platforms UK