What is a Put Option?

A put option is a derivative contract between a seller

and a buyer. It provides the buyer with the right to

sell a specific asset at a certain price within a certain

time period. Here’s a look at put options.

A put option is a written contract between a seller and a buyer that gives the option buyer the right to sell

an asset (typically a stock) at a certain price within a certain period of time. The buyer doesnt have to

sell the stock during that time frame, but has the option to do so. The option seller, on the other hand, is

obligated to buy the stock if the option holder decides to exercise his options.

Parts of a Put Option

The put option contract includes certain details. The strike price is the price at which the option can be

sold. The option premium is the price the buyer pays for the option. The expiration date is the date by

which the option must be used or it will become void. When the put option expires, the option purchaser

can no longer sell the option at the strike price. Though the strike price is quoted per share, put options

are sold in contracts representing 100 shares of stock each.

Option premiums are higher for longer expiration dates since theres a greater chance of the stock falling

over longer time periods. Option premiums are also higher when the strike price is higher than the

market value of the underlying stock.

Why Buy a Put Option

The put option buyer has the advantage of selling a stock for a higher price even though the price of the

stock has dropped as long as the option is exercised before the expiration date. Since the value of a put

option increases as the value of the stock falls, you would purchase a put option when you expect a

stock’s value to fall. Thats when an option contract is considered in-the-money and you can make a

profit. Of course, put options are less attractive when the value of a stock is expected to increase since

the value of the option will drop.

Selling Put Options

The seller of put options only makes money when the

purchaser doesnt exercise the option before it expires.

So, you would sell a put option when you think the stock

price will either go up or remain the same. In that case,

youd never have to purchase the stock from the option

buyer. Instead, youd keep the option premiums as profit.

Put Option Example

Lets say you purchase a 60-day put option for XYZ

stock with a strike price of $30 at $2.20 per option

contract. You purchase price for the contract would be

$220, representing 100 shares of stock. Within a few

weeks, the price of the stock drops to $20 and the put

option price per share rises to $3.60 per option. You decide to sell for $360 and your profit is $140. That

s more than 60% return on your investment.

If the value of the put option drops or the option expires before you exercise it, the most you lose is the

option premium. In the previous example, you would have lost $220 if you didnt exercise your option to

sell.

The break-even point for a put option is the difference between the strike price and the option premium. If

the strike price for a stock is $50 and the option premium is $5, the break-even price is $45.

Calculating Put Option Profitability

You can quickly calculate whether the option is in-the-money or out-of-the-money by comparing the

current market value of the stock from the strike price. When the price of the stock drops below the strike

price, the put option is in-the-money. On the other hand, the option is out-of-the-money when the stock

price rises above the strike price.

Heres a financial calculator that lets you know the value of a put option based on the options purchase

price, number of shares the option controls, the options strike price, and the stocks current share price.

Based on what you enter, the calculator lets you know whether the option is in-the-money or out-of-the-

money and your net loss or gain.

Options investing involves risk and is not suitable for all investors. It is possible for an options investor to

lose the entire amount committed to with options in a relatively short period of time. Copies of the

Options Disclosure Document are available upon request by contacting your representative or by

contacting the Options Clearing Corporation at 1-800-678-4667. You may also visit their website www.