Put options are financial contracts that give the buyer the right, but not the obligation, to sell 100 shares of an underlying stock at a predetermined price (the strike price) by a specific date (the expiration date). Think of a put option as an insurance policy – just as you might buy insurance to protect your car’s value, you can buy puts to protect your stock’s value or sell puts to collect income by providing that insurance to others. Understanding puts is essential for options trading, as they form half of all options strategies and can be used for protection, speculation, or income generation.
Basic Put Option Mechanics
Every put option contract represents 100 shares and has several key components:
Strike Price: The price at which you can sell (or be forced to buy) the shares Expiration Date: The last day the option can be exercised Premium: The price paid for the option contract Underlying: The stock or ETF the option is based on
Put options have inverse relationship with stock price – they increase in value as the stock price falls and decrease in value as the stock price rises.
The Two Sides of Put Options
Buying Puts (Long Puts)
When you buy a put, you pay a premium for the right to sell shares at the strike price. Buyers typically:
- Want to protect existing stock holdings (hedging)
- Believe the stock price will fall (bearish speculation)
- Seek to limit downside risk while maintaining upside potential
Maximum Loss: The premium paid Maximum Gain: Strike price minus premium (×100), if stock goes to $0 Breakeven: Strike price minus premium paid
Selling Puts (Short Puts)
When you sell a put, you collect a premium but accept the obligation to buy shares at the strike price if assigned. Sellers typically:
- Want to generate income from their cash
- Are willing to buy the stock at a lower price
- Believe the stock price will stay flat or rise
Maximum Loss: Strike price minus premium (×100), if stock goes to $0 Maximum Gain: The premium collected Breakeven: Strike price minus premium received
Put Option Moneyness
In-the-Money (ITM): Strike price is above the current stock price
- Example: $50 strike put when stock is at $45
- Has intrinsic value of $5 ($50 – $45)
At-the-Money (ATM): Strike price equals the current stock price
- Example: $50 strike put when stock is at $50
- Has no intrinsic value, only time value
Out-of-the-Money (OTM): Strike price is below the current stock price
- Example: $50 strike put when stock is at $55
- Has no intrinsic value, only time value
Real-World Put Examples
Example 1: Buying a Put for Protection
You own 100 shares of XYZ at $50 (worth $5,000) and buy a 30-day $48 put for $1.00:
- Cost: $100 (100 × $1.00)
- Protection: Can sell at $48 even if stock drops to $40
- Maximum loss: $300 (($50-$48) × 100 + $100 premium)
- If stock stays at $50: Lose the $100 premium
Example 2: Selling a Put for Income
XYZ is trading at $50, you sell a weekly $48 put for $0.50:
- Income: $50 (100 × $0.50)
- Cash secured: $4,800
- ROR: 1.04% for one week ($50/$4,800)
- Annualized ROR: 54.2%
- If stock stays above $48: Keep the $50
- If stock falls to $46: Buy 100 shares at $48, effective cost $47.50
Put Option Pricing Factors
Stock Price: As stock price falls, put values increase Strike Price: Higher strikes are more valuable for puts Time to Expiration: More time = higher premium Volatility: Higher volatility = higher premium Interest Rates: Higher rates slightly decrease put values Dividends: Expected dividends increase put values
Time Decay (Theta)
Put options lose value over time, with decay accelerating as expiration approaches:
- Far from expiration: Slow, steady decay
- 45-21 days out: Decay accelerates
- Final week: Rapid decay, especially for OTM puts
Put sellers benefit from time decay, while put buyers fight against it.
Implied Volatility (IV)
IV represents the market’s expectation of future price movement:
- High IV = expensive options (higher premiums)
- Low IV = cheap options (lower premiums)
- IV often spikes before earnings or major events
- Put sellers prefer high IV (collect more premium)
- Put buyers prefer low IV (pay less premium)
Common Put Strategies
Cash Secured Puts: Sell puts backed by cash, willing to buy shares Protective Puts: Buy puts to hedge long stock positions Put Spreads: Buy and sell puts at different strikes to define risk/reward Naked Puts: Sell puts without full cash backing (requires margin)
Assignment and Exercise
For Put Sellers:
- Assignment means you must buy 100 shares at the strike price
- Usually happens at expiration if ITM
- Early assignment is rare but possible with American-style options
For Put Buyers:
- You can exercise anytime before expiration (American-style)
- Usually only beneficial if deep ITM near expiration
- Often better to sell the put than exercise
Put Option Greeks
Delta: Rate of price change relative to stock movement
- Highest for ATM options near expiration
Theta: Time decay rate
- Negative for put buyers, positive for put sellers
Vega: Sensitivity to implied volatility changes
- Positive for both put buyers and sellers
Rho: Sensitivity to interest rate changes
- Generally minimal impact on puts
Risk Management with Puts
Position Sizing: Never risk more than you can afford to lose Diversification: Don’t put all capital in one underlying Exit Planning: Know your profit target and stop loss before entering Rolling: Extend duration or adjust strikes to manage positions
Tax Considerations
Put Premiums:
- Sellers: Taxed as short-term capital gains when expired/closed
- Buyers: Premium is part of basis if exercised, capital loss if expired
Protective Puts: May affect holding period for covered shares Wash Sales: Be aware of wash sale rules when trading the same underlying
Always consult a tax professional for your specific situation.