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WIKI ANALYSIS| 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 buyer the right, but not the obligation, to sell a specified quantity of a security at a set strike price on or before an agreed upon expiration date. In this sense, a put option is very similar to a put warrant. Timing of exercising the option depends on whether it is an American option or European option. If the option buyer decides to exercise the put option, the counterparty who sold, or wrote the option, must buy the underlying security at the agreed upon strike price, even if the market price for that security has fallen below the strike price.
In other words, when you buy a put option, you are buying the right to sell your stock at the strike price regardless of the stock price in the future before expiration. For example, if a stock you are holding is trading at $50 right now and you buy a put option with a $50 strike price, you have the right to sell that stock for $50 no matter how low the stock price falls in the future. Even if the stock falls to $10, you can still sell that stock for $50 as long as the put option has not expired. One point to notice is that unlike call options and warrants, put options have a limited profit. The lowest price a security can ever reach is zero, meaning the most profit you can ever earn is the full strike price. Since the payoff of purchased put options increases as the stock price falls, buying put options is considered bearish.
Conversely, you can short or "write" a put option, giving the buyer 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, also known as the price of the put. If the stock rises to above $50, the buyer of the put option will never exercise the option to sell you that stock for $50, so the option expires worthless and you pocket the premium as profit. Since the payoff of sold, or written put options increases as the stock price rises, selling put options is considered bullish.
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.
See Also
External Links
- Put Options by Optiontradingpedia.com
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