What is a 'Put'
A put is an option contract giving the owner the right, but not the obligation, to sell a specified amount of an underlying asset at a set price within a specified time. The buyer of a put option believes the underlying asset will drop below the exercise price before the expiration date. The exercise price is the price the underlying asset must reach for the put option contract to hold value. The possible payoff for a holder of a put option contract is illustrated by the following diagram:
BREAKING DOWN 'Put'Derivatives are financial instruments that derive value from price movements in the underlying asset. The underlying asset can be a commodity such as gold or stock. Derivatives are largely used as insurance products to hedge against the risk of a particular event occurring. There are two main types of derivatives used for stocks: put and call options.
Puts and Calls
A call option gives the holder the right, but not the obligation, to buy a stock at a certain price in the future. When an investor buys a call, she expects the value of the underlying asset to go up. A put is the exact opposite. When an investor purchases a put, she expects the underlying asset to decline in price. The investor then profits by selling the put option at a profit or exercising the option. An investor can also write a put option for another investor to buy. If an investor writes a put contract, she does not expect the stock's price to drop below the exercise price.
Each option contract covers 100 shares. With that in mind, consider the investor who purchases one put option contract for 100 shares of ABC company at $1 per share, or $100 ($1*100). The exercise price of the shares is $10, and the current ABC share price is $12. This put option contract has given the investor the right, but not the obligation, to sell shares of ABC at $10.
If ABC shares drop to $8, the investor's put option is in the money and she can close her option position by selling the contract on the open market. On the other hand, she can purchase 100 shares of ABC at the existing market price of $8, and then exercise her contract to sell the shares for $10. Disregarding commissions, the total profit for this position is $200, or 100*($10 - $8).
There are other ways to work a put option as a hedge. If the investor in the previous example already owns 100 shares of ABC company, it is referred to as a "married put" position and serves as a hedge against a decline in share price.