The Basics of a Put Option

What is a Put Option?

A put option is a contractual agreement between the buyer and the seller of the option that gives the right, but not the obligation, for the put holder to force the seller of the put to purchase the underlying security at the strike price on the options expiration date. The buyer of a put option believes that the stock may move lower and therefore, decides to purchase the insurance to protect the downside risk and thereby locks in a sales price if the stock moves lower. See the option risk profile of a put online to understand the risks and rewards.

Puts may also be used for speculative purposes; if you short a put without it being a part of a larger strategy, this is called a "naked" put. The seller of a naked put is taking a bet that the stock will move higher and that the premium that was received will expire worthless.

You can generally say that the price of a put option moves lower as the stock moves higher and visa versa. The risk of buying a put option is merely the amount of money that was paid for the option. However, a put writer, or seller, has unlimited risk. The writer will be responsible for purchasing the stock at a predefined price no matter how low the stock goes.

A put option consists of two components; time premium and intrinsic value (strike price - current price). As the option gets closer to expiration, the time premium will rapidly disappear and the option holder will be left with the intrinsic value. It is generally safe to say that this accelerated decay in time value begins 1 month prior to expiration.

See You At the Top,

mysmp.com