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What is a Put Option?
A put option is a financial contract that gives the holder the right, but not the obligation, to sell an underlying asset at a specified price within a defined time period.
Definition
A put option is a derivative instrument that allows the holder to sell an asset at a predetermined strike price before or at expiration.
Key Takeaways
- Gives the right to sell, not buy, an asset.
- Commonly used for hedging or speculation.
- Increases in value when the underlying asset price falls.
Understanding Put Options
Put options are widely used in options trading to profit from declining prices or to protect existing investments. The buyer of a put option pays a premium for the right to sell the underlying asset at the strike price.
If the market price falls below the strike price, the option becomes valuable. If the price remains above the strike price, the option may expire worthless, and the buyer’s loss is limited to the premium paid.
Sellers (writers) of put options receive the premium but take on the obligation to buy the asset if the option is exercised.
Key Components of a Put Option
Underlying Asset: The security being sold.
Strike Price: The agreed selling price.
Expiration Date: The last date the option can be exercised.
Premium: The cost of the option.
Real-World Example
An investor owns shares of a company trading at $50 and buys a put option with a strike price of $45. If the stock falls to $40, the investor can sell at $45, limiting losses.
Importance in Business or Economics
Put options are important risk management tools. They allow investors and firms to hedge against downside risk, support price discovery, and contribute to market liquidity and efficiency.
Types or Variations
Protective Put: Used to hedge an existing long position.
Speculative Put: Used to profit from expected price declines.
European Put: Exercisable only at expiration.
American Put: Exercisable anytime before expiration.
Related Terms
- Call Option
- Options Premium
- Derivatives
Sources and Further Reading
- Investopedia — Put Option
- CME Group — Options Basics
- Corporate Finance Institute — Put Option Explained
Quick Reference
- Right to sell an asset at a set price.
- Used for hedging or speculation.
- Downside risk limited to premium paid.
Frequently Asked Questions (FAQs)
How does a put option make money?
When the underlying asset price falls below the strike price.
Is buying a put risky?
Risk is limited to the premium paid.
Who uses put options?
Investors, traders, and firms managing downside risk.
