Put Options - InvestMentor

Introduction to Put Options

A put option is a financial contract that grants the buyer the right, but not the obligation, to sell an underlying asset, such as a stock, at a predetermined price called the strike price within a specific time frame.

This instrument allows investors to potentially profit from a decline in the asset's price or to protect existing holdings against losses.

After learning about call options, Delilah becomes interested in how put options can help her safeguard her portfolio against market downturns.

Rights and Obligations of Buyers

Buyers of put options, known as holders, have the right to sell the underlying asset at the strike price before the option expires.

This right provides a form of insurance against price declines, enabling the holder to lock in a selling price even if the market value falls below the strike price.

The maximum loss for the buyer is limited to the premium paid for the option.

This mechanism is especially useful for investors seeking to hedge existing positions against potential losses.

Timothy Buys a Put Option

Timothy, an investor concerned about potential market declines, owns 100 shares of GlobalTech Corp., currently trading at $60 per share.

To protect against losses, he buys a put option with a $55 strike price, expiring in two months, paying a $150 premium.

This gives Timothy the right to sell his shares at $55 each if the price drops below that level.

If the stock price stays above $55, Timothy can let the option expire, limiting his loss to the $150 premium while keeping his shares.

Rights and Obligations of Sellers

Sellers of put options, or writers, are obligated to buy the underlying asset at the strike price if the buyer chooses to exercise the option.

In return, they receive the premium paid by the buyer upfront.

If the asset's price remains above the strike price, the option expires worthless, and the seller keeps the premium as profit.

However, if the price falls below the strike price, sellers may face significant losses, as they must purchase the asset at a price higher than the market value.

Delilah Sells a Put Option

On the other side of Timothy’s trade is Delilah, our course’s heroine. Confident that GlobalTech Corp.’s stock price will stay above $55, she sells a put option with a $55 strike price, expiring in two months, for a $150 premium.

As the seller, Delilah must buy 100 shares at $55 if Timothy exercises the option.

If the price stays above $55, the option expires worthless, and she keeps the premium. If it falls below $55, she may need to buy shares, risking losses based on the market price.

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