What Is a Put Option?
A put option is a derivative contract that gives its holder the right, but not the obligation, to sell an underlying asset at a specified strike price on or before an expiration date. The buyer pays a premium for this right, and the seller of the put is obligated to buy the asset at the strike if the option is exercised.
Puts are the mirror image of calls: they become more valuable as the underlying price falls below the strike. That makes them useful both for speculating on declines and for insuring an existing position against a drop.
How It Works
A put is in the money when the underlying trades below the strike. At expiration, a put is worth the greater of zero or the strike price minus the underlying price, so a put buyer's maximum gain occurs if the asset falls all the way to zero, while the maximum loss is the premium.
Buying puts against stock you own is called a protective put, and it works like an insurance policy: you pay a premium to cap your downside at the strike. Put sellers collect premium income but commit to buying the stock at the strike if it falls, which some investors use deliberately to acquire shares at lower prices.
Example
Suppose a stock trades at $60 and you buy a put with a $55 strike for a $1.50 premium. If the stock drops to $45, the put is worth $10 at expiration, an $8.50 profit per share on a $1.50 outlay. Your breakeven is 55 - 1.50 = $53.50.
If the stock stays above $55, the put expires worthless and you lose the $1.50 premium, the full extent of your risk.
Why It Matters
Puts let investors profit from or protect against declines with strictly limited risk, unlike short selling, where losses are theoretically unlimited. The prices of puts relative to calls also reveal how much the market is paying for downside protection, a key sentiment gauge for traders.
Hedge funds and derivatives desks use puts constantly for hedging, so fluency with put payoffs is expected in any sales and trading or buy-side interview.
