Put options explained

Author: Steven posted in Stock options tagged with put options

A put option is a contract between two parties (buyer and seller) that enables the option holder (holder) to sell the underlying asset to the writer (seller) at a given price, known as the strike price or exercise price, within a defined timeframe. As for all equity option contracts, each contract refers to 100 shares of the underlying stock and the there are no ownership rights involved such as dividend payouts. If the put option is not exercised within the defined timeframe, it expires worthless.
As a put option holder you would exercise your right to sell the shares of the underlying stock only if the market price of the stock would drop below the strike price. The difference between the two would represent your profit (less any commission involved for the transaction). The price that you pay to buy the option is known as the premium. Such premium, or option market price, varies based on several factors, such as the current share price of the underlying security, its volatility, the strike price and the duration of the option. The price of the underlying security is the most important variable. The premium goes to the writer of the option that has the legal obligation to buy the shares at the agreed price. Whether the put option is exercised or not by the option holder, the option writer keeps the premium. As the market price of the underlying asset decreases, the value of the put option increases. You can then trade your put option in the open market just as done with other securities.
If the option holder does not exercise the put option, the most he/she would lose would be the premium paid multiplied by the number of shares (100 shares per option contract).
Whereas a major advantage of puts and options in general is the leverage they provide, the option holder does not enjoy any of the benefits associated with being the owner of the underlying stock shares, such as income from dividend payouts or voting rights.

When is a put option in-the-money
A put option is said to be in-the-money when the current share price of the underlying stock is below the strike price. If the strike price is the below the market price, then it is out-of-the-money.

If you haven’t already done so, make sure you read our introductory article on stock options trading as well as the article on call options.

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