A put option is the opposite of a call option. It is a financial contract that gives the buyer the right, but not the obligation, to sell an asset (like a stock) at a specific price, on or before a specific date.

Think of it as an insurance policy against a stock's price dropping.

The Simple Analogy

Imagine you own a rare collectible watch that you bought for $2,000. You love the watch, but you hear rumors that a cheaper, better version is about to be released, which could cause the value of your watch to drop.

You find a collector who is willing to pay you a fee of $100 for a contract that gives you the right to sell your watch to them for a locked-in price of $1,800 anytime in the next three months.

  • The Contract (The Put Option): The agreement for a guaranteed sale price.

  • The Right, Not the Obligation: If the price drops to $1,000, you will use the contract. If the price rises to $3,000, you won't use it—you'd sell it on the open market for the higher price.

  • The $100 (The Premium): This is the fee you pay for the insurance. It's your maximum potential loss.

  • The $1,800 (The Strike Price): This is the fixed price at which you can sell the watch.

  • The Three Months (The Expiration Date): This is the deadline for the contract.

How a Put Option Works in the Stock Market

When you buy a put option on a stock, you are betting that the stock's price will fall significantly before the contract expires.

TermSimple DefinitionKey DetailPut BuyerYou (the person paying the fee)Wants the stock price to go DOWN (or is protecting a stock they already own)Put Seller (Writer)The person collecting the feeWants the stock price to stay UPUnderlying AssetThe stock or asset (e.g., Tesla stock)Each contract typically controls 100 shares of the asset.Strike PriceThe fixed price you can sell the shares for.If the stock price is lower than the Strike Price, your option has value.PremiumThe price you pay for the option contract.This is your maximum loss (you lose the premium if the option expires worthless).

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The Example: Speculating on a Decline

You believe the stock for XYZ Co. is overvalued and is about to crash.

  • Current Stock Price (XYZ Co.): $50 per share.

  • You buy 1 Put Option:

    • Strike Price: $45

    • Expiration: 1 month from now

    • Premium Paid: $2 per share, or $200 total (since one contract controls 100 shares).

Scenario 1: The Stock Drops (You win the bet)

  • At expiration, XYZ Co. is trading at $35 per share.

  • You now have the right to sell shares at $45, even though they are only worth $35 on the market.

  • To profit, you buy 100 shares on the market for $35 and immediately exercise your option to sell them for $45.

  • Gross Profit Per Share: $45−$35=$10

  • Net Profit: ($10 per share×100 shares)−$200 (premium paid)=$800

Scenario 2: The Stock Rises (You lose the bet)

  • At expiration, XYZ Co. is trading at $55 per share.

  • Your right to sell shares at $45 is worthless, as you can sell them for $55 on the open market.

  • You simply let the option expire worthless.

  • Net Loss: You lose only the Premium you paid: $200.

Why Investors Use Put Options

  1. Speculation: To profit from a predicted drop in a stock's price with less capital than short selling.

  2. Protection (Hedging): To act as an insurance policy for a stock you already own. If you bought a stock at $100 and buy a $90 Put, your maximum loss is the difference between your purchase price and the strike price, plus the premium paid. It locks in a minimum sale price.