What are put options?

Question

I'm finding it a little hard trying to comprehend what a put option is, since it doesn't make sense NOT to buy one. Is it sort of like an insurance against a dropping stock? If I bought a stock at $100, and buy a put option to sell it at $80 and the stock drops to $50, does it mean I can sell it all for $80? Can someone explain this clearly?

Answer 1

A put option can be insurance against a stock you already own. In your example, you bought the stock at $100 and a put option at a strike price of $80. The stock drops to $50, thus you lost $50 per share on the stock. But the put option is now "in the money" meaning it has both intrinsic and time value. The intrinsic value is the difference between the price of the stock and the strike price ($80 strike minus $50 stock price gives you $30 intrinsic value). The time value is how much time premium is still left in the option.

Invest t is wrong. You don't sell it for $80, that's the price the stock value must pass through for the option to be in-the-money. In the above example, with the stock being at $50, the put option with have $30 in intrinsic value and some time value - let's say $3 in time value. So, the price of the options is $33, which means if you sold the option, you'd sell it for $33 X 100 shares or $3,300. Your stock lost $50 in value (say you have 100 shares) so you lost $5000 in the value of the stock. You sold the put for $3,300, so your net loss is only $1,700. The increase of the value of the put offset the loss in the stock.

In a nutshell, a put option takes advantage of a declining price. If you feel the price of a stock is going to decline, you can buy a put option to take advantage of that price decline. Let's take the above example again, but this time you don't own the stock, you just believe the stock is going to decline and want to take advantage of the price decline. So, the stock is trading at $100/share and you feel it's going to decline to $75/share, so you buy a put with an strike price of 80 and the premium for the options is say $5. An option controls 100 shares, so at $5, the premium you'd pay is $500 ($5 x 100 shares = $500). Now, let's say that the stock has a violent sell off to $50. One of the components of an option price is volatility, so if volatility is high, the premium will go up drastically, so the stock drops to $50, which is $30 in the money and the volatility is high. Thus with the option being $30 in the money and volatility adding to the premium, let's say the option is now worth $39, so you could sell the option for $39 and make $3900, less the $500 when you bought it for a net profit of $3400. Or you can exercise the option. When you exercise the option, the exercise is assigned to a counter party and the stock is PUT to them (that's why the call it a put option) - meaning that when you exercise the option, the stock is bought in the market at $50 per share and it PUT to the assignee and they have to pay the strike price of $80, thus locking in a $30 per share profit.

So summarize, put options can be used to:

1) Act as an insurance policy against a price decline in stock you already own.

2) Take advantage of the stock falling in price and profiting off of that price decline. Like buying a call would take advantage of prices climbing in value, a put takes advantage of the price declining in value.

Answer 2

From a CBOE tutorial:

Put Options are options to sell a stock at a specific price on or before a certain date. In this way, Put options are like insurance policies
If you buy a new car, and then buy auto insurance on the car, you pay a premium and are, hence, protected if the asset is damaged in an accident. If this happens, you can use your policy to regain the insured value of the car. In this way, the put option gains in value as the value of the underlying instrument decreases.

If all goes well and the insurance is not needed, the insurance company keeps your premium in return for taking on the risk.

With a Put Option, you can "insure" a stock by fixing a selling price.
If something happens which causes the stock price to fall, and thus, "damages" your asset, you can exercise your option and sell it at its "insured" price level.

If the price of your stock goes up, and there is no "damage," then you do not need to use the insurance, and, once again, your only cost is the premium.

This is the primary function of listed options, to allow investors ways to manage risk.

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The reason that it does often does not make sense to buy a put option is simply that you may believe the premium is too expensive. All options have expiration dates, so if you want protection all the time you have to buy another put option every time the previous one expires.

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Yes. you have the right to sell the stock any time before expiration for $80 regardless of the price at which the stock is trading.

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You should also undestand that a lot of people trade put options without any real consideration of the insurance value of the option. For example, a speculator may believe the price of a stock is going to go down from $100 to $50 he may simply buy the $80 put to profit from the increase he expects in the price of the option.

Answer 3

the definition of put option is:
The put allows the buyer the right but not the obligation to sell a commodity or financial instrument (the underlying instrument) to the writer (seller) of the option at a certain time for a certain price (the strike price).

some people do use put option as a strategy to protect their long position of stock against unexpected dropping of their stock value, it calls protective put. for your example, if you do everything correctly, you can exercise your put option, and the person who wrote(option writer or seller) the put option must buy it $80 from you, even the stock drops it to $1 or even goes bankrupt. or you can sell your put option since your put option contract will appreciate.

more detailed explains check out below link
http://en.wikipedia.org/wiki/Put_option

Answer 4

The earlier answers are correct. The primary reason NOT to buy one is that you expect the stock to go up in price. If a stock is performing well and you expect it to continue to do so, then buying puts wouldn't make sense.

On the other hand, if the market in general or the stock in particular is unsettled, then put buying MIGHT make sense.

Answer 5

In user-friendly english, a placed is the staggering to sell a inventory at a series value for the period of a undeniable quantity of time. i will make up some numbers. you think of microsoft is overpriced, so which you purchase a million march 30 placed for $2 hundred. you presently have the staggering to sell a hundred shares of microsoft at $30 a share each time previously expiration in march. (constantly the 0.33 friday of the month). If microsoft drops to $26 a share, you are able to the two basically sell the alternative, or workout it. in case you workout it, you sell a hundred shares at $30 and purchase them lower back at $26. you preserve the $4 hundred distinction (minus the $2 hundred you paid for the choice at the beginning).