How put options work

Put Option Definition: A put option is an option contract in which the holder buyer has the right but not the obligation to sell a specified quantity of a security at a specified price strike price within a fixed period of time until its expiration. For the writer seller of a put option, it represents an obligation to buy the underlying security at the strike price if the option is exercised.

Call and Put Options Defined

The put option writer is paid a premium for taking on the risk associated with the obligation. For stock options, each contract covers shares.

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Note: This article is all about put options for traditional stock options. If you trading robot three in one looking for information pertaining to put options as used in binary option tradingplease read our writeup on binary put options instead as there are significant difference between the two. Buying Put Options Put buying is the simplest way to trade put options.

  • Buyer of option pays you amount through brokers and the exchange Helps reduce you loss or increase profit.
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  • This pre-determined price that buyer of the put option can sell at is called the strike price.
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  • A put option is a contract that gives its holder the right to sell a set number of equity shares at a set price, called the strike pricebefore a certain expiration date.

When the options trader is bearish on particular security, he can purchase put options to profit from a slide in asset price. The price of the asset must move significantly below the strike price of the put options before the option expiration date for this strategy to be profitable. You strongly believe that XYZ stock will drop sharply in the coming weeks after their earnings report.

Let's take a look at how we obtain this figure. This strategy of trading put option is known as the long put strategy.

how put options work

See our long put strategy article for a more detailed explanation as well as formulae for calculating maximum profit, maximum loss and breakeven points. Protective Puts Investors also buy put options when they wish to protect an existing long stock position.

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  2. How Is a Put Option Exercised?

Put options employed in this manner are also known as protective puts. Entire portfolio of stocks can also be protected using index puts.

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Selling Put Options Instead of purchasing put options, how put options work can also sell write them for a profit. Put option writers, also known as sellers, how put options work put options with the hope that they expire worthless so that they can pocket the premiums.

how put options work

Selling puts, or put writing, involves more risk but can be profitable if done properly. Covered Puts The written put option is covered if the put option writer is also short the obligated quantity of the underlying security.

how put options work

The covered put writing strategy is employed when the investor is bearish on the underlying. Naked Puts The short put is naked if the put option writer did not short the obligated quantity of the underlying security when the put option is sold.

Put Option

The naked put writing strategy is used when the investor is bullish on the underlying. For the patient investor who is bullish on a particular company for the long haul, writing naked puts can also be a great strategy to acquire stocks at a discount.

The financial product a derivative is based on is often called the "underlying.

Put spreads limit the option trader's maximum loss at the expense of capping his potential profit at the same time.