wealtheducation-what_is_a

What is a Put?

A put option is a type of financial instrument known as a derivative. It is basically an agreement between parties to exchange ownership of a stock at an agreed upon price within a certain time period. The exchange of the stock is optional and the owner of the put option decides whether it takes place.

The agreed upon price of the exchange is called the strike price. The date on which the put option expires is the expiry date. The amount of money required to purchase this put option is called the premium. If the exchange takes place, then one is said to have exercised the put option.

Put option premiums are always quoted per stock, but sold in lots of 100 shares minimum. Put options are always an agreement about being able to sell the stock at the agreed upon price. Put options come in both European style and American style.

European style put options are sold on European exchanges, while American style put options are sold in North American exchanges. The difference is quite simple. European options can only be exercised on the expiry date, while American style options can be exercised at any time during the life of the put option.

There are two investment styles when investing in put options. Conservative investors purchase a put option on stock that is part of their portfolio as an insurance policy against a large drop in the price of the stock. For example, if a conservative investor owns stock in company A and is concerned that the stock price may decline, but is unwilling to sell the stock in A, a put option can be purchased to insure that if A stock were to dramatically decline in price, the investor would be able to sell the stock at the strike price of the put option. If A stock is selling at 50 US dollars (USD), a put option could be purchased with a strike price of 48 USD.

At any time during the life of the put option, the owner may sell A stock for 48 USD per share. This would only be done if the price of the A share were to fall below 48 USD. The price of this put option will be dependant upon a number of variables but will be much less then 48 USD, typically in the 1 to 2 USD range. This example assumes an American style put option. Remember also that put options can only be purchased in lots of 100 shares.

What is Out of the Money?
What is In the Money?
What is At the Money?