A put option is a contract that gives the option holder the right, but not obligation, to sell a set amount of shares (100 shares per contract) at a set price. If the option is exercised, the option writer must purchase the shares from the option holder.

[Put and call options are the two fundamental tools for option trading. If you're new to option trading, Investopedia's Options for Beginners Course will show you the mechanics of options and how they can be used for both hedging and speculation, with over five hours of on-demand video, exercises, and interactive content.]

The opposite of a put option is a call option, which gives the holder the right to purchase a set amount of shares at a set price. Whether a put or a call option, however, the option holder can exercise or act on the contract at any time (American option) until its expiration date.

If the holder wants to exercise the contract, he or she simply lets the broker know of the intent to exercise. For example, if Max purchases one March $10 put option on Ford Motor Co., it gives him the right to sell 100 shares of Ford at $10 before the expiration date in March, which usually falls on the third Friday. If Max already holds 100 shares of Ford, his broker will simply sell these shares at the $10 price. In this case, Max would realize a gain if the current price for which he could sell the Ford shares in the market was below the $10 exercise price. For example, if, after Max has purchased the put option, shares fall to $5, he would still be able to sell 100 shares at $10 ($1,000) instead of the $500 ($5 x 100) for which he could currently sell the shares in the market. This transaction would represent an economic gain of $500 for Max.

Now let's assume that Max does not have shares of Ford Motor Co. in his account and he notifies his broker that he wants to exercise the option. Max's broker could then purchase 100 shares of Ford at $5 and sell them at $10. In this case, Max would also receive a gain of $500 on the option.

The other alternative to exercising an option is to simply sell the option back to the market. If Max chooses this route, the price he would receive in the market would be equivalent to the gain of exercising. In this case, each option would sell for $5, which would cost a purchaser $500 - this price is determined by the price of the option times the shares it controls ($5 x 100).

To learn more, see Options Basics and Trading A Stock Versus Stock Options - Part 1.

  1. How do I change my strike price once the trade has been placed already?

    Learn how the strike prices for call and put options work, and understand how different types of options can be exercised ... Read Answer >>
  2. What is index option trading and how does it work?

    Learn about stock index options, including differences between single stock options and index options, and understand different ... Read Answer >>
  3. How Do Speculators Profit From Options?

    Options are a risky game, but you can learn speculators' tricks to use them to your advantage. Read Answer >>
  4. Does the seller (the writer) of an option determine the details of the option contract?

    The quick answer is yes and no. It all depends on where the option is traded. An option contract is an agreement between ... Read Answer >>
Related Articles
  1. Trading

    Options Hazards That Can Bruise Your Portfolio

    Learn the top three risks and how they can affect you on either side of an options trade.
  2. Trading

    Exploring European Options

    The ability to exercise only on the expiration date is what sets these options apart.
  3. Investing

    Why Options Trading Is Not for the Faint of Heart

    Trading options is not easy and should only be done under the guidance of a professional.
  4. Trading

    How to Sell Put Options to Benefit in Any Market

    As long as the underlying stocks are of companies you are happy to own, put selling can be a lucrative strategy.
  5. Investing

    Take Advantage of Employee Stock Options

    If your employer offers stock options, they can contribute to your long-term financial success. Here's how.
  6. Trading

    How to Trade Options on Government Bonds

    A look at trading options on debt instruments, like U.S. Treasury bonds and other government securities.
  1. Call On A Call

    A type of compound option in which the investor has the right ...
  2. European Option

    An option that can only be exercised at the end of its life, ...
  3. Capped Option

    A security that features a maximum limit on the holder's profit ...
  4. Options On Futures

    An option on futures gives the holder the right but not obligation ...
  5. Put

    An option contract giving the owner the right, but not the obligation, ...
  6. Put Option

    A put options is an option contract giving the owner the right, ...
Hot Definitions
  1. Perfect Competition

    Pure or perfect competition is a theoretical market structure in which a number of criteria such as perfect information and ...
  2. Compound Interest

    Compound Interest is interest calculated on the initial principal and also on the accumulated interest of previous periods ...
  3. Income Statement

    A financial statement that measures a company's financial performance over a specific accounting period. Financial performance ...
  4. Leverage Ratio

    A leverage ratio is any one of several financial measurements that look at how much capital comes in the form of debt, or ...
  5. Annuity

    An annuity is a financial product that pays out a fixed stream of payments to an individual, primarily used as an income ...
  6. Restricted Stock Unit - RSU

    A restricted stock unit is a compensation issued by an employer to an employee in the form of company stock.
Trading Center