options

Put Option Definition with a Simple Example

Stock Market Guides is not a financial advisor. Our content is strictly educational and should not be considered financial advice.

If you're having trouble understanding what a put option is, you're not alone. The term itself is not intuitive as far as we're concerned. What exactly is the word "put" supposed to indicate?

First of all, stock options are a tool in the stock market that allows investors to potentially benefit from the movement of stock prices.

They are leveraged, which means you can get more bang for your buck than you can compared to buying the corresponding stock. That extra bang can equate to either more profits or more losses.

When it comes to stock options, there are two types: call options and put options.

Here's a video that gives more context to the definition of a put option:

 

Put Option Definition

Owners of put options typically benefit when the price of a stock goes down. That is the opposite of call options, where owners typically benefit if the price of a stock goes up.

Here is a simple way to look at it. If you think a stock price might go down, you could short the stock to capture profit on that potential price decrease. You could also buy a put option for the same purpose.

So in other words, shorting a stock and buying a put option typically both involve the same hope: that the stock price will go down.

If you need more help getting up to speed on options, take a look at our guide to options trading for beginners.

 

Put Option Example

Here's an example of how a put option works. Imagine you're looking at Bank of America stock.

That's a stock chart for Bank of America. Maybe you feel that the stock price is poised to sink within the next few weeks.

You could short the stock itself, which is trading at $28.88 per share as shown in the image above.

Or you could consider buying a put option.

Here are put options that are available to buy for Bank of America:

You can see the put options at the far right of the options chain in the image.

The options in the image have an expiration date that is about three weeks away. It shows the bid and ask of each put option that's available.

If we pick one example, say the 29 strike put options, you can buy them right now for 0.76.

Since option contracts each control 100 shares of stock, it means you would pay $76 to buy one put option contract (plus brokerage fees).

Compare that to shorting 100 shares of the stock, which would require a lot more buying power.

Now imagine that the stock price of Bank of America went down to $27 in the next few weeks. Whether you short the stock or own the put option in this example, the value of your position will have gone up.

But the put option required a lot less capital due to the leverage that options afford investors.

 

Put Options: Other Considerations

The example above offered a pretty simplistic idea of how put options work. There are other factors at play to be aware of, though.

 

Overcoming Extrinsic Value in Put Options

The price of many options includes some amount of extrinsic value. You can think of it as a premium you pay to be able to control the option.

Due to this extrinsic value, when you buy a put option, the price of the corresponding stock might have to down up some degree just to offset that premium before being able to turn a profit, particularly the longer you hold the option.

 

Selling Put Options

Our example above demonstrated how it works to buy a put option. But it's also possible to sell a put option.

If you sell a put option, you benefit if the price of the underlying stock does not go down.

Selling a put option also has a different buying power impact than buying a put option.

 

Picking the Best Put Options to Buy

If you like the idea of using call options as an investment vehicle, then you can consider learning options trading strategies.

If you'd rather leave it to the pros but still want good option investment ideas, you can consider signing up for our options alert service.