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| This article is part of WikiProject Definitions. Consider editing to improve it. View articles referencing this definition. |
A put option is a financial instrument that conveys the right, but not the obligation, to sell a specified quantity of a security at a set price at some time on or before expiration. Timing of exercising the option depends on whether it is an American option or European option. Upon the option holder's choice to exercise the option, the party who sold, or wrote, the option must buy the option to fulfill the terms of the contract.
In layman terms, when you buy a put option, you are buying the right to sell your stock at the strike price of the put option no matter what price the stock may be in the future. For example, if a stock you are holding is trading at $50 right now and you buy its put option at the strike price of $50, you can always sell that stock for $50 no matter how low that stock goes in the future. Yes, even if the stock falls to $10, you can still sell that stock for $50 as long as the put option has not expired! In this regard, you would only buy a put option when you are of the opinion that the stock is going to go down.
Conversely, when you short or "write" the above put option, you are giving someone else the right to sell you that stock for $50 at anytime before the option expires. To compensate you for that risk taken, the buyer pays you a premium, much like insurance premium. If the stock rises to above $50, there will be absolutely no sense for the buyer of the put option to sell you that stock for $50, so the option expires worthless and you pocket the premium as profit. Obviously, you will only short or "write" a put option when you are of the opinion that the stock is going to rise.
Every put option has the following three characteristics:
- Strike price: this is the price at which you can sell your stock (if you have bought a put option) or the price at which you must buy the stock (if you have sold a put option).
- Expiry date: this is the date on which the option expires, or becomes worthless, if nobody exercises it.
- Premium: this is the price you pay when you buy an option and the price you receive when you sell an option.
[edit] See Also
[edit] External Links
- Put Options by Optiontradingpedia.com
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