Put options are one type of option contract that can be traded. Call options are the other type. Puts give the option holder the right to sell the underlying stock at a selected price. Buying put options and selling put options are opposite strategies with different risks and rewards.
Put Contract Features
Each put option contract includes the underlying stock, the strike price and the expiration date. The put option owner has the right, until the expiration date, to exercise the put and sell 100 shares of the underlying stock for the strike price. Options on a particular stock are available in a range of strike prices above and below the current value of the stock. Expiration dates include the current month, the following month and at least every third month out to nine months in the future.
Buying Put Options
A trader buys a put option to profit from a decline in the value of the underlying stock. When the underlying stock price moves below the put option strike price, the option increases in value dollar-for-dollar as the stock price moves lower. If the stock is below the strike price, the put option is said to be in-the-money (ITM). When the stock price is above the strike price, the put is out-of-the-money (OTM). Buying a put becomes profitable when the stock moves below the strike price by an amount greater than the premium paid for the put option.
Selling Put Options
The trader who sells put options wants the stock price to stay level or go up. The put seller receives the price or premium paid by the put buyer and must be ready to buy the stock shares if the option is exercised. The profit for the put seller occurs if the option reaches expiration out-of-the-money. The maximum amount of profit is the money received from selling the put option. If the stock price goes in-the-money, the profit on the sold put will be reduced by the amount the stock is ITM.
Rewards and Risks
The put buyer only has the amount paid for the put options at risk. Depending on the relationship between the strike price, stock price and expiration, the options cost between a few dollars and a few hundred dollars per contract. If the stock goes in-the-money, the put buyer's option value goes up $100 for every dollar the stock drops in price. The put seller receives the price of the options, which is the maximum profit from the trade. If the stock drops below the strike price, the seller loses $100 for every dollar the stock price declines. Potential losses can be thousands of dollars.