Definition:
A put option is an option contract in which the holder (buyer) has the right (but not the obligation) to sell a specified quantity of a security at a specified price (strike price) within a fixed period of time (until its expiration).
For the writer (seller) of a put option, it represents an obligation to buy the underlying security at the strike price if the option is exercised. The put option writer is paid a premium for taking on the risk associated with the obligation.
A standard U.S. equity option usually represents 100 shares. Corporate actions can produce adjusted contracts with different deliverables; check the contract multiplier and OCC adjustment terms. This page describes physically settled stock options. Cash-settled options have different settlement mechanics.
Buying Put Options
Put buying is the simplest way to trade put options. When the options trader is bearish on a particular security, they can purchase put options to profit from a slide in its price. At expiration, the stock must finish below the strike by more than the premium paid for the trade to be profitable before costs. Before expiration, a sale depends on the option’s market price.
A Simplified Example
Suppose the stock of XYZ company is trading at $40. A put option contract with a strike price of $40 expiring in a month's time is being priced at $2. You strongly believe that XYZ stock will drop sharply in the coming weeks after their earnings report. So you paid $200 to purchase a single $40 XYZ put option covering 100 shares.
Say you were spot on and the price of XYZ stock plunges to $30 after the company reported weak earnings and lowered its earnings guidance for the next quarter. Buying shares at $30 and exercising the put to sell them at $40 would produce a profit of $800 before costs.
Let's take a look at how we obtain this figure.
If you were to exercise your put option after earnings, you invoke your right to sell 100 shares of XYZ stock at $40 each. If you do not already own the shares, buying 100 shares at $30 and delivering them through exercise at $40 produces a $1,000 difference between sale proceeds and share purchase cost. Subtract the $200 option premium and the net profit is $800 before transaction costs. The share purchase requires funds; exercising without owning the deliverable can instead create a short stock position, subject to broker and borrowing requirements.
This strategy of trading put option is known as the Long Put strategy. See our Long Put strategy article for a more detailed explanation as well as formulae for calculating maximum profit, maximum loss and breakeven points.
Protective Puts
Investors also buy put options when they wish to protect an existing long stock position. Put options employed in this manner are also known as Protective Puts. Entire portfolio of stocks can also be protected using index puts.
Selling Put Options
Instead of purchasing put options, one can also sell (write) them and receive a premium. Put option writers may hope that the options expire worthless. Premium income is not guaranteed profit: an assigned stock put writer must buy the shares at the strike, even if their market value is much lower.
Covered Puts
The written put option is covered if the put option writer is also short the obligated quantity of the underlying security. The Covered Put writing strategy is employed when the investor is bearish on the underlying.
Naked Puts
The short put is naked if the put option writer did not short the obligated quantity of the underlying security when the put option is sold. The naked put writing strategy is used when the investor is bullish on the underlying.
For an investor willing and able to buy the stock, writing a Cash-Secured Put can establish a potential purchase price equal to the strike minus premium before costs. Assignment is not guaranteed, and the shares can fall well below that effective price. A Cash-Secured Put differs from the short-stock Covered Put described above.
Put Spreads
A put spread combines bought and sold put options on the same underlying with different strikes and/or expirations. A conventional matched vertical spread uses the same expiration and bounds the option payoff at that expiration. Calendar and Diagonal Spread involve different expiration dates, so the value of the remaining option must be considered; their profit and risk cannot be read from a single common-expiration payoff line.
Breakeven, maximum profit and maximum loss
For the $40-strike put bought for $2 per share, breakeven at expiration is $38 before costs. At $39, its $100 value leaves a $100 loss. At $40 or above it expires worthless and the full $200 premium is lost. For a stock that cannot trade below zero, maximum profit is finite: ($40 − $2) × 100 = $3,800 if the stock falls to zero.
A short-stock Covered Put can suffer unlimited loss as the stock rises. A standalone short stock put has a finite but substantial maximum loss if the stock falls to zero. Reserving cash for assignment does not eliminate that downside exposure.
Selling to close, time value and earnings
You can sell an option you own to close the position while its market is open, instead of exercising it. Selling may preserve remaining time value that exercise gives up. Before expiration, the premium depends on more than intrinsic value: time remaining and implied volatility also matter. Time decay or a fall in implied volatility after earnings can offset a favorable stock move.
The exercise right in these examples assumes an American-style contract. European-style options restrict exercise to expiration. Confirm the broker’s expiration instructions and the funding or share obligations that exercise can create.
