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Buys a put option

A put option allows investors to bet against the future of a company or index.

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  • This leverage allows you to reap outsized rewards if you're correct; if you're wrong, the most you'll lose is the premium paid.
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More specifically, it gives the owner of an option contract the ability to sell at a specified price any time before a certain date.

Put options are a great way to hedge against market declines, but they, like all investments, come with a bit of risk. For starters, you can lose not only what you invested, but also any chance for profits.

What Is a Put Option?

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Buying a put option gives you the right to sell a stock at a certain price — the strike price — any time before a certain date. This means you can require whoever sold you the put option — the writer — to pay you the strike price for the stock at any point before the time expires. However, you are under no obligation to do so.

Put Options: What Are They and How to Buy Them - SmartAsset

Buying put options is a way to hedge against a potential drop in share price. They could also reap profits from bear markets or declines in the prices of individual stocks.

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You should also understand the risks associated with put option investing, though. This reliance on other securities makes options generally more complicated and risky than investors who focus on individual securities, like stocks and bonds.

In the worst-case scenario, losses for some derivatives can be nearly limitless, so tread lightly.

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Since you own the shares, this buys a put option called a covered option. How to Buy Put Options To buy put options, you have to open an account with an options broker.

What to Consider When Buying Put Options in Stock Trading

The broker will then assign you a trading level. That limits the type of trade you can make based on your experience, financial resources and risk tolerance. To buy a put option, first choose the strike price.

This will normally be somewhat below where the stock is currently trading.

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Next choose an expiration date. This could typically be from a month to a year in the future. Longer time periods generally mean less risk.

Instrument models[ edit ] The terms for exercising the option's right to sell it differ depending on option style. A European put option allows the holder to exercise the put option for a short period of time right before expiration, while an American put option allows exercise at any time before expiration. The put buyer either believes that the underlying asset's price will fall by the exercise date or hopes to protect a long position in it. The advantage of buying a put over short selling the asset is that the option owner's risk of loss is limited to the premium paid for it, whereas the asset short seller's risk of loss is unlimited its price can rise greatly, in fact, in theory it can rise infinitely, and such a rise is the short seller's loss.

Next decide how many contracts to buy. Each options contract is for shares of stock.

Put options: Learn the basics of buying and selling

For each contract you will pay the listed premium for that option, plus brokerage fees. You can exercise the option at any time before the expiration date. If current prices fall below the strike price, the option is considered in the money.

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If your option is in the money, you can require the writer of the option to purchase your shares at the higher strike price. But you have to buy the shares before exercising the that uncovered put option. You can buy put options on indexes as well as individual securities.

This can produce profits from broad declines in bear markets. Of course, the buys a put option prices might not decline below the strike price.

Then the put option buyer would let the option expire unused.

Put option

Buying uncovered put options gives an investor lots of leverage. Bottom Line Buying put options can be a simple and less risky way to trade options.

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Put options can hedge portfolios and produce profit during falling markets. They can help you figure out those details and weigh the benefits and risks of put options against similar alternatives.

Retirement Calculator show more Many or all of the products featured here are from our partners who compensate us. This may influence which products we write about and where and how the product appears on a page. However, this does not influence our evaluations. Our opinions are our own. Put options are the lesser-known cousin of call options, but they can be every bit as profitable and exciting as their more popular relative.

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This pre-determined price that buyer of the put option can sell at is called the strike price. Put options are traded on various underlying assets, including stocks, currencies, bonds, commodities, futures, and indexes.

A call option allows an investor purchase a stock, bond, commodity or other security at a certain price, within a specific time frame. If the price of your investment increases, your gains could multiply. However, if the price drops, you could lose money.