Put Option Definition:
A put option is a type of security that you buy when you think a price of a stock or index is going to go down. More specifically, a put option is the right to sell one lot of shares of a stock or an index at a certain price by a certain date. That “certain price” is known as the strike price, and that “certain date” is known as the expiry or expiration date.
A put option, like a call option, is defined by the following 4 characteristics:
- There is an underlying stock or index to which the put option relates
- There is an expiration date of the put option
- There is a strike price of the put option
- The option is either the right to sell (this would be a put) or the right to buy (this would be a call)
It is called an put option because it gives you the right to “put”, or sell, the stock or index to someone else.
So, again, what is a put option? Since put options are the right to sell, owning a put option allows you to lock in a minimum price for selling a stock. I say a “minimum selling price” because if the market price is higher than your strike price of your put, then you would just sell the stock at the higher market price and not exercise it. It is called a “put option” because it allows you to “put” the stock on somebody (ie, sell it to them).
When to Buy Put Options:
If you think a stock price is going to go down, then there are 3 ways you can profit from a falling stock price:
- you can short the stock
- you can write a call on the stock, or
- you can buy a put option on the stock.