If you think the market price of the underlying stock will stay flat or move up, you can consider selling or "writing" a put option. For a put buyer, if the market price of the underlying stock moves in your favor, you can elect to "exercise" the put option or sell the underlying stock at the strike price.
American-style options allow the put holder to exercise the option at any point up to the expiration date. European-style options can be exercised only on the date of expiration. Buying and selling put options can be used as part of more complex option strategies.
Put options can function like a kind of insurance for the buyer. A stockholder can purchase a "protective" put on an underlying stock to help hedge or offset the risk of the stock price falling because the put gains from a decline in stock prices. But 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 the stock outright.
The buyer has two choices: First, if the buyer owns the stock, the put option contract can be exercised, putting the stock to the put seller at the strike price. This illustrates the "protective" put because even if the stock's market price falls, the put buyer can still sell the shares at the higher strike price instead of the lower market price.
Second, the buyer can sell the put before expiration in order to capture the value, without having to sell any underlying stock. Then the put seller keeps the premium paid for the put while the put buyer loses the entire investment. The graph below shows the put buyer's profit or payoff on the put with the stock at different prices. The other is short selling.
The difference between the sell and buy prices is the profit. There's a reason why put buyers get excited. Buying puts offers better profit potential than short selling if the stock declines substantially. In contrast, short selling offers less profitability if the stock declines, but the trade becomes profitable as soon as the stock moves lower. Key Takeaways Put options give holders of the option the right, but not the obligation, to sell a specified amount of an underlying security at a specified price within a specified time frame.
Put options are available on a wide range of assets, including stocks, indexes, commodities, and currencies. Put option prices are impacted by changes in the price of the underlying asset, the option strike price, time decay, interest rates, and volatility. Put options increase in value as the underlying asset falls in price, as volatility of the underlying asset price increases, and as interest rates decline. Put options lose value as the underlying asset increases in price, as volatility of the underlying asset price decreases, as interest rates rise, and as the time to expiration nears.
Selling vs. Exercising an Option The majority of long option positions that have value prior to expiration are closed out by selling rather than exercising , since exercising an option will result in loss of time value, higher transaction costs, and additional margin requirements. Compare Accounts. The offers that appear in this table are from partnerships from which Investopedia receives compensation. This compensation may impact how and where listings appear.
Investopedia does not include all offers available in the marketplace. Related Terms How a Put Works A put option gives the holder the right to sell a certain amount of an underlying at a set price before the contract expires, but does not oblige him or her to do so.
Strike Price Definition Strike price is the price at which a derivative contract can be bought or sold exercised. Options Contract Definition An options contract gives the holder the right to buy or sell an underlying security at a predetermined price, known as the strike price.
What Is an Outright Option? An outright option is an option that is bought or sold individually, and is not part of a multi-leg options trade. What Is Capping? Capping is the practice of selling large amounts of a commodity or security close to the option's expiry date to prevent a rise in market price. Vanilla Option Definition A vanilla option gives the holder the right to buy or sell an underlying asset at a predetermined price within a given time frame.
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I Accept Show Purposes. The put seller keeps any premium received for the option. For a small upfront cost, a trader can profit from stock prices below the strike price until the option expires.
By buying a put, you usually expect the stock price to fall before the option expires. It can be useful to think of buying puts as a form of insurance against a stock decline. Buying puts is appealing to traders who expect a stock to decline, and puts magnify that decline even further. Here are the advantages of selling puts. The payoff for put sellers is exactly the reverse of those for buyers.
Sellers expect the stock to stay flat or rise above the strike price, making the put worthless. The appeal of selling puts is that you receive cash upfront and may not ever have to buy the stock at the strike price. As a put seller, your gain is capped at the premium you receive upfront. Typically investors keep enough cash, or at least enough margin capacity, in their account to cover the cost of stock, if the stock is put to them.
If the stock falls far enough in value you will receive a margin call, requiring you to put more cash in your account. The other major kind of option is called a call option, and its value increases as the stock price rises. In this sense, calls act the opposite of put options, though they have similar risks and rewards:.
For more, see the basics you need to know about call options. But investors can also use options in a way that limits their risk while still allowing for profit on the rise or fall of a stock. MoMo Productions. How We Make Money. Editorial disclosure. James Royal. Written by. Bankrate senior reporter James F. Non-standard options typically vary from the share increment. Pro tip: When the market price of your underlying stock falls below break-even the strike price minus the premium you paid, excluding commissions , it is profitable.
This trade is known as a long put strategy. Like call options, specific strategies exist for put options. Some of the more common strategies include protective puts , put spreads, covered puts and naked puts. A protective put also known as a married put lets you shield the securities you own from price declines. How so? You continue to hang onto your existing shares taking a long position , while also having put options, which can be thought of as an insurance policy or a hedge against price declines.
Since potential growth of a stock is limitless, you can say that the profit potential of a protected put is also limitless, minus the premium paid. There are two types of put spreads: bull put spreads and bear put spreads. When executing a spread, you are both a buyer and seller. A bull put spread is an options strategy you could use if you expect the underlying asset to experience a moderate price increase.
To employ this strategy, you first buy a put option paying a premium , then you sell a put option on the same security with a higher strike price than the one you bought, receiving a premium for the sale. The maximum net profit is the difference between what you receive from selling the put and what you pay for buying the other. On the other hand, a bear put spread is a strategy used when you expect a moderate to large price decline in the underlying asset.
You purchase put options and sell the same number of put options for the same security and with the same expiration date, but at a lower strike price.
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