DEFINITION of 'Put On A Put'
One of the four types of compound options, this is a put option on another underlying put option. The buyer of a put on a put has the right but not the obligation to sell the underlying put option - also known as the vanilla option - on the expiration date. This type of option is used when leverage is desired, and the trader is moderately bullish on the underlying asset. The value of a put on a put changes in direct proportion to the price of the underlying asset, i.e. it increases as the asset price increases, and decreases as the asset price decreases.
Also known as a split-fee option.
BREAKING DOWN 'Put On A Put'
A put on a put has two strike prices and two expiration dates, one for the initial compound put option and the other for the underlying vanilla put option. Note that compound options are generally European-style exercise, which means that they can only be exercised on the expiration date.
Since one of the variables that determines the cost of an option is the price of the underlying asset, the cost of a put on a put option will generally be lower than the cost of a put on the corresponding asset. It can therefore provide a great deal of leverage to the options trader.