Table Of Content
What Is a Put Option and How Does It Work?
A put option is a financial contract that gives the holder the right—but not the obligation—to sell an asset at a set price (known as the strike price) before a specific expiration date.
Investors typically buy put options when they expect the asset’s price to drop, aiming to sell it at a higher strike price than the future market price.
On the other hand, selling (or “writing”) a put option means the seller is taking on the obligation to buy the asset at the strike price if the buyer chooses to exercise the option.
Put options are commonly used for hedging and speculation. Key features include:
The strike price determines the value of the contract at expiration
The premium is the upfront cost paid by the buyer to the seller
The option’s value increases as the underlying asset’s price decreases
Sellers can profit if the asset stays above the strike price (option expires worthless)
Put options are widely used in equity markets to protect against falling stock prices or to bet on downward moves
Examples of Using Put Options
To better understand how put options work in real scenarios, here are a few examples illustrating both buying and selling put contracts, with outcomes ranging from profit to loss.
These scenarios show how put options can be used strategically for both protection and profit, depending on market movement.
Action | Strike | Premium | Stock Price at Expiry | Profit/Loss Per Share |
|---|---|---|---|---|
Buy Put (Profit) | $50 | $2.00 | $40 | +$8.00 |
Buy Put (Loss) | $50 | $2.00 | $52 | -$2.00 |
Sell Put (Profit) | $45 | $1.50 | $48 | +$1.50 |
Sell Put (Loss) | $45 | $1.50 | $40 | -$3.50 |
Put Options Main Strategies: Who Uses Them and Why
Put options are versatile tools used by different types of investors for varying goals such as hedging, income, or speculation.
Hedging against stock losses: Long-term investors often buy puts to protect their portfolios. For example, an investor holding Apple stock may purchase a put option with a $170 strike price to cap downside risk during earnings season.
Speculating on price drops: Traders use puts to profit from expected declines. If a trader believes Tesla will fall from $250 to $200, they might buy a put and profit if the stock drops.
Generating income: Investors also sell puts on stocks they want to buy at lower prices. If Meta trades at $300, selling a $280 put for $5 earns income while potentially acquiring the stock at an effective price of $275.
Creating synthetic positions: Advanced strategies like a synthetic short involve buying a put and selling a call, mimicking short-selling without actually borrowing shares.
These strategies serve both defensive and offensive purposes, depending on market outlook
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Put Option Buyer vs. Seller – Key Differences
Feature | Put Option Buyer | Put Option Seller |
|---|---|---|
Objective | Protect asset or profit from a decline | Earn premium or buy stock at a lower price |
Rights/Obligations | Right to sell at strike price | Obligation to buy if assigned |
Risk Level | Limited to premium paid | Potentially large losses if stock drops sharply |
Profit Scenario | Stock price drops below strike price | Stock stays above strike price |
Example Use Case | Buying a $100 put on Tesla before earnings | Selling a $95 put to buy Tesla at a discount |
Why Put Options Are Very Risky?
While put options offer flexibility, they also carry significant risks—especially for sellers and inexperienced buyers.
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Limited Time For Profit
A purchased put option has a fixed expiration. If the stock doesn’t move below the strike price in time, it becomes worthless, and the entire premium is lost.
For example, buying a $100 put on Netflix that expires while the stock holds above $100 results in a total loss of premium.
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Unlimited Downside For Sellers
Selling puts can backfire if the stock drops sharply.
If you sell a $60 put on a biotech stock and it plunges to $30 after bad FDA news, you're obligated to buy it at $60, incurring a major loss.
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Volatility Can Work Against You
If implied volatility falls after you buy a put, its value can decrease even if the stock price drops slightly.
This happens because options are priced based on volatility expectations, not just direction.
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Margin Requirements
Selling puts often requires margin, which can lead to forced selling if the market moves sharply.
Therefore, retail traders need to assess capital needs before using these strategies.
How to Buy and Sell Put Options on a Brokerage Platform
Buying or selling a put option through an online broker is straightforward, but understanding each step is crucial to avoid costly mistakes.
Open an options-enabled account: Most brokers like Schwab or Interactive Brokers require an application and approval before you can trade options. Approval level depends on your experience and financial situation.
Choose a stock and strategy: Decide whether you're buying a put to speculate or hedge, or selling a put to earn premium income.
Select strike price and expiration: If the stock is trading at $100, you might buy a $95 put expiring in one month. This affects both cost and potential profit.
Place the order: In your brokerage dashboard, choose “Buy to Open” or “Sell to Open” and review the bid-ask spread. Limit orders are often better than market orders.
Manage the position: Monitor the option's value, and close or exercise it before expiration if needed. If you sell puts, be prepared to buy the stock if assigned.
FAQ
If the stock price is above the strike price, the option expires worthless. If it's below, the buyer may choose to exercise it and sell the stock at the strike price.
Put options can be risky, especially for sellers who may be forced to buy the stock at a higher price than market value. Buyers risk losing the premium if the stock doesn’t move down.
Yes, you can sell it on the open market anytime before expiration. The value will depend on how much time is left and how far the stock is from the strike price.
The strike price is the predetermined price at which you can sell the underlying stock. It's a key factor in determining your profit or loss.
If you sold a put and the stock drops below the strike price, you may be assigned, meaning you must buy the stock at the strike price. This usually happens near expiration.
Both profit from a falling stock price, but puts have limited risk and don’t require borrowing shares. Short selling has unlimited downside and stricter margin requirements.
Yes, higher volatility raises put premiums because there's more potential for the stock to fall. Traders often buy puts ahead of uncertain events for this reason.
Yes, but it’s important to understand the risks and mechanics first. Most brokers require you to apply and be approved for options trading.
No, you don’t need to own the stock. Buying a put is a standalone strategy that profits if the stock price drops below the strike.
