How It Works
A put option gives the holder the right, but not the obligation, to sell 100 shares of an underlying stock at a specified strike price before or at the expiration date. The buyer pays a premium upfront for this right. When the stock price falls below the strike price at expiration, the option is "in the money" (ITM). The holder can exercise the option to sell shares at the higher strike price, profiting from the decline. If the stock price stays at or above the strike price, the option expires worthless and the buyer loses the premium paid.
Example Problem
You buy 1 put option contract with a strike price of $100 for a premium of $5 per share. Your total cost is $5 × 100 = $500. If the stock drops to $85 at expiration, what is your profit?
- Contract cost: $5 × 100 shares × 1 contract = $500
- Intrinsic value at expiration: ($100 − $85) × 100 = $1,500
- Net profit: $1,500 − $500 = $1,000
- Break-even price: $100 − $5 = $95
Key Concepts
Key terms: Strike Price (K) is the price at which the option holder can sell the stock. Premium is the cost per share to buy the option contract — total contract cost is Premium × 100 × Number of Contracts. Break-Even Price for a put equals Strike Price − Premium. Maximum Loss is limited to the total premium paid (the contract cost). Maximum Gain is limited to (Strike Price − Premium) × 100 × Contracts, occurring when the stock drops to $0.
Frequently Asked Questions
When should I buy a put option?
Put options are typically purchased when you expect the underlying stock price to decline before the expiration date, or as a hedge to protect an existing long stock position against downside risk (known as a protective put).
What happens if the stock price stays above the strike price?
The option expires worthless and you lose the entire premium paid. This is the maximum possible loss when buying a put option.
What is the break-even stock price for a put?
For a long put option, the break-even price equals the strike price minus the premium per share. The stock must trade below this level at expiration for you to realize a net profit.
How is the maximum gain for a put option calculated?
The maximum gain occurs when the stock price drops to zero. In that case, you profit from selling at the full strike price minus the premium you paid. The formula is (Strike Price − Premium) × 100 × Number of Contracts.
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