Complete Guide to Put Options

Exchange-traded options have been around since as far back as 1973. You’ve probably only heard of them in the context of their riskiness and complexity, but once you understand how options work, they can prove to be a very valuable part of your strategy.

When used correctly, put options can help you manage risk and may quickly become a key part of your hedging strategy.

When used incorrectly though, just like any powerful tool, they can cause significant damage.

Throughout this guide, we aim to help you understand how put options work and the advantages they bring to the table, where to trade them, and the key strategies to implement for the best results.

Breaking Down the Call Option 👇

Options trading involves both “call” and “put” options. If we’re going to understand options trading, we need to first clarify the call option.

When it comes to U.S. style options, a call option contract gives the buyers the right to purchase the underlying asset at an agreed price at any stage up until the expiry date, but without any obligation to do so. European-style options vary in that buyers cannot exercise their options contract before the date of expiration.

Strike Price ⚡️

The strike price is an agreed price where a call buyer can purchase the underlying asset. For example, a stock call option buyer with a strike price of $20 can buy that stock at that same price of $20 before it expires.

What the Call Buyer Gets 📜

The buyer of the call option has the right to buy a stock at the predetermined price (also called the strike price) during a certain time frame. To earn this right, the buyer pays the premium price.

Should the price of the underlying asset move higher than the strike price, then the option will be valuable. The buyer can then sell the option to make a profit or pay commissions in order to exercise the options contract themselves.

What the Call Seller Gets 💰

The call seller/writer gets the premium price. In this way, selling call options is one way to make an income. However, the amount you can make from selling call options is capped at the premium price. On the other hand, a call buyer could potentially make an unlimited amount.

Put options can be traded on various underlying assets, including currencies, stocks, bonds, futures, indexes, and commodities. In this sense, there is a stark difference between stocks and options.

Put options can be contrasted with call options, where the holder has the right to buy the underlying asset at an agreed price, either on the date of expiry of the options contract or before. These definitions are key to know when to perform a straddle or strangle, which we will get to soon.

How Do Put Options Work? 🛠️

The other key aspect of options trading is the put option. These become more valuable the more the price of the underlying stock goes down. In accordance, put options lose value the more the price of the underlying security increases.

When a put option is exercised, traders can take a short position in the underlying asset. Due to this, hedgers and speculators favor them.

Put options contracts can be used as a form of risk management, particularly in the protective put strategy. Although we’ll go into this in more detail soon, a protective put is generally utilized as a form of investment insurance to limit losses in the underlying asset.

Generally, put options decrease in value as it becomes closer to the expiration date. This is because of time decay, which references how probable it is that a stock falls below the specified price. 

Once the option has lost its time value, the intrinsic value remains, which is equal to the strike price minus the underlying stock price. Should you be lucky enough to be left with an option that has an intrinsic value at the expiry date, it is known as in the money.

Should an option be out of the money or at the money, the put option will have no intrinsic value because it will not be worthwhile exercising the option. 

Investors could short sell the stock at the current market price, as opposed to exercising an out-of-the-money put option at strike price, but this can be riskier than buying options.

How Does a Put Option Make Money? 💰

The top options trading strategies are only popular because they make money. Let’s take a deeper look at how trading strategies with put options make money.

The extrinsic or time value of the option is reflected in the premium. Let’s say the strike price of a put option is $10 and the underlying stock is trading at $9. Then there is an intrinsic value of $1.

But the option may trade at $0.20. That additional $0.20 is time value, as the price of the underlying stock could very possibly move before the expiry date. Varying options with the same underlying asset can be combined to become put spreads.

Can I Sell My Put Option Anytime? ⏳

Investors generally trade a put or call option when it is expected that the stock will move in a certain period of time, typically shortly before or after an earnings report, business event, merger, or acquisition. When buying a call the investor expects the market price of the underlying asset to increase before the options contract expires, and can earn a profit by buying the stock for a lower than its market value.

Is Selling a Put Option Bullish or Bearish? 🐂 🐻

Generally, selling a put is a bullish strategy, as the price of put options usually declines over time, should the price of the asset in question increase. In addition, it depends on the expiration date, strike price, the implied volatility level, and delta.

Put Options vs. Call Option ⚖️

The difference between put options and call options can be simply explained: 

Put options allow investors can to sell stock at a certain date for an agreed amount of money. Call options allow investors to buy stocks at a later date at a predetermined price.

Time Value, Volatility, and “In the Money” 👍

Not only does the market price of the underlying asset affect the value of the put option, other factors play a part in affecting it, too. These include implied volatility, time value, and whether the contract is in the money, or not.

To begin, the time value is the probability of the underlying security’s price declining below the strike price before the contract’s expiry date. Thus, all put options experience time decay. Essentially, the value of the contract falls the closer the expiry date nears.

Aside from time value, the volatility of the underlying security also affects the price of a put option. When it comes to a long position on the stock market, volatility isn’t always a positive. With options though, increased volatility for a particular stock increases the price of the put option.

Primarily, this is down to the fact that the put option bets on the price swings of the underlying stock within a period of time. This means that the more volatile the underlying stock is, the more expensive the put option on that security.

What Does it Mean to Be “In the Money”? 💸

A major factor to take into consideration when buying a put option is whether it is in the money, or not, or it’s intrinsic value. When put options are said to be “in the money”, it means that the underlying security costs less than the strike price of the option. If you haven’t guessed, it’s called in the money because it is in profit – were you to exercise the option right there and then, you would make a profit. 

With this in mind, when a put option is referred to as “at the money”, it means the underlying security is priced the same as the strike price, and, in accordance, when a put option is “out of the money”, it means the security is currently priced higher than the strike price.

Due to the fact that in the money put options are more valuable, they are more expensive. For this reason, if you are considering buying put options, and are bearish, it is suggested to buy put options that are out of the money because they will be cheaper.

Puts vs. Short Selling ✔️

Buying put options can be a good strategy if you think a stock is predicted to decrease, and it’s a key way to wage against a stock. Another key way to wager against a stock is through short selling with a reliable broker. To do this, investors borrow stock from their broker with the intent of selling it on the market and hoping that the price declines so they can buy it back at a cheaper rate.

As mentioned briefly above, what differentiates the sell and buy prices is the profit potential. Puts have unlimited profit potential, while shorting a stock has a capped profit potential, and this is why it’s an attractive option for put buyers. Nonetheless, the strategy you choose will be vital to your success. Here are some of the main strategies to understand.

Put Option Strategies 🎯

While put options are generally traded to capitalize on a bearish strategy towards a certain stock, there are a variety of other ways to maximize bearishness and minimize risk. There are a number of popular options trading strategies in general, and put options are heavily involved.

Long Put 📉

A long put strategy is one of the most basic for put options.

Investors buying a long put option are bearish on the underlying security and predict that the price of the security will fall within a particular time period.

For example, should an investor go bearish on Apple (AAPL), you could consider buying a put option on Apple stock with a strike price of $300 per share, with the hopes that its market value will fall to $295 in six months time. Since apple stock is currently $352.08, your put option would be considered out of money, and therefore cheaper.

The more bearish you go on the stock, the more you should go out of the money when buying the stock. However, should the stock price fall before your option expires then you could make a profit by exercising your put option and selling the Apple stock shares at $300 as opposed to the current lower price on the stock market.

In many cases, long options are good strategies as they don’t require you to fork up the necessary capital to go long in a more expensive asset or stock, such as Apple. It can also pay off in a volatile market.

And, since a put option contract gives you the right (and not the obligation to) sell the underlying asset, your risk and potential losses will be limited.

Short Put 📈

A short put strategy, also known as a naked put, would expect the underlying stock to increase in price, or that it stays the same as the strike price – therefore this is a more bullish strategy than a long put.

Similar to a short call, a short put is mainly to make the price of the premium on the stock. A short put works by selling a put option – particularly one that’s more out of the money if you are implementing a more conservative strategy.

The risk with this strategy is that losses are not capped, and could be substantial. Given that you are selling a put option, where the put to plummet to zero, or close, you have an obligation to buy a pretty worthless stock.

If you decide to sell options, you do have an obligation to buy or sell it i.e. instead of having merely the right to buy or sell, you are obligated. Due to this, it is riskier to sell put options on individual stocks than it is to sell ETFs, commodities or indexes.

For short puts, sellers will want the price of the stock to be higher than the strike price (so it becomes worthless to the buyer) – and then you will successfully receive the premium. 

However, they differ from buying options in that the more volatility there is the worse it is for this strategy. In relation to time decay, although it usually is a negative factor for options strategies, this strategy benefits from it as the aim is to create a worthless contract.

Bear Put Spread 🐻

As we have seen, long puts are generally quite bearish on the stock market. If you’re looking for something just a little less bearish than this, a bear put spread is often used when an inventor wants to be semi bearish on stocks.

To devise a bear put spread, investors short an out of the money put option and at the same time, they buy an in the money put for an increased rate – both puts will have exactly the same expiry date and amount of shares.

It differs from the short put in that the loss for this strategy is limited to the amount you bought the spread for, because the worst you can expect is for the stock to close at a higher price than the strike price of the long put, rendering contracts on both sides useless. That said, the most profit you can make is limited, too.

A benefit of the bear put spread has to be the fact that a volatile market won’t be an issue with this strategy because the investor is taking both a short and long position on the option (once your options aren’t too far out of the money). Furthermore, time decay, similarly to volatility, will not really have a negative effect taking into account how balanced the structure of the spread is. 

Essentially, a bear put spread utilizes a short put option to firstly, sponsor the long put and secondly, to cap risk.

Protective Put 🛡️

With the nickname the “married put”, the protective put strategy is not too dissimilar to the covered call in that it enables investors to protect their stock through a long position.

From an analogy standpoint, the protective put is an ideal show of how options can be used as a sort of insurance for a stock position.

In order to implement a protective put strategy you should purchase a put option for every 100 shares of stock you have, at a particular strike price.

Were the stock price to plummet lower than the strike price of the put option, you would lose the money you put on your stock, but actually, you’ll be in the money for your put option. This will cap your losses to the amount that your option is in the money.

Put Option Example ☑️

Now let’s look at an example of the strategies we went through above. X stock is currently trading at $100 per share, and for $10 per contract, investors can a put with a $100 strike price that expires in 1 year. The investor has $1,000, which let’s her buy 10 shares of the stock, or one put contract. Every options contract is representative of 100 shares. 1 contract x $10 x 100 = 1,000.

See below the payoff profile at the expiry date for put buyers, put sellers, and short sellers.

Put buyers get excited for a reason. If the stock falls 40% and makes $400, then options multiply this to $3,000 for the owner of the put. Put buyers have better profit potential than short sellers should the stock fall dramatically.

A put buyer could lose their whole investment if the stock were to fall below the strike by the expiry date, but it will have a capped loss of the initial investment amount. The example below will look at how the put buyer cannot lose more than $1,000.

By contrast, investors who short sell have less potential for profit if the stock falls, but they will make a profit once the stock moves down. At $95, a profit has already been made, while the put owner has just made his own money back.

Short sellers biggest advantage though, is that the time frame they have for the stock to fall is longer. While options do expire eventually, a short seller does not need to close their short position, once the broker can maintain the position with enough capital.

The biggest downside to short selling is that investors can, in theory, lose an infinite amount if the stock keeps increasing. But stocks don’t soar an infinite amount, you’re thinking. And you are right. Nonetheless, short sellers have the potential to lose a lot more than their initial investment sum.

If the stock price continued to rise, the short-seller might have to put up additional capital in order to maintain the position.

On the other hand, put sellers have a dramatic disadvantage and a capped advantage. The most a put seller can make is the price of the premium – $1,000 – but they have to be ready to purchase a hefty 100 stock shares for the strike price if that becomes the case (should the stock be put to them).

There is a potential for loss that exceeds the initial investment amount and could come to the whole stock value, were the underlying stock to fall to $0. In this case, the put seller can potentially lose up to $10,000 were the underlying stock to fall to $0.

Think this might be something you’re interested in? Here’s how to buy a put option.

Put Option Trading Tips 🎯

Put options are popular because they give investors more options in how they invest. Here are some choices they offer investors:

Generate Income from the Premium ✅

 A fair strategy, once done in moderation, is to create income by selling options. Investors could see returns on an annual basis even on high-quality stocks and a low volatile market. This is an attractive option, particularly when it comes to a rising market, where there is less of a chance that the stock will be put to the seller.

Generate a Capital Gain with Limited Risk ✅

Many investors use put options to limit the risk they are exposed to. For example, should an investor want to make a profit off the decline of a stock, they could purchase a put contract and cap the total loss to $500, whereas a short seller on the other hand has the potential for unlimited loss if the stock increases. While both strategies offer pretty similar rewards, the put position caps the potential loss.

More Tempting Prices 🪙

Put options can also be used to receive more attractive buying prices on stocks. Many investors sell puts on stock that they want to have but can’t afford at the minute.

Should the price decline lower than the strike price, then they can purchase the stock and use the premium as a discount on the buy. Should the stock stay higher than the strike price, they can hold onto the premium and simply use the strategy again.

Where Do I Trade Put Options? 🤔

If you’re ready to start trading, it’s ideal to start with one of the top brokers for options trading. There are a number of popular options trading platforms, with each offering their own strengths and weaknesses.

Apps such as Robinhood are great for “do it yourself” options traders who want to trade without paying any commissions, and don’t need a bunch of technical indicators. Other trading platforms such as TradeStation are a favorite among active, high-volume traders.

Similarly to call options, investors can buy put options through brokers that specifically facilitate advanced options trading, such as 24Option and eOption. Options are traded through a broker in a similar way as stocks or bonds because they are financial instruments. 

Here are how some of the most popular brokers for options trading compare:

How Do I Buy A Put Option? 👛

Buying put options is a slightly different process because they are more or less a contract on the underlying security (and not the security itself).

Generally, to trade options, you will need the approval of a brokerage for a particular level of options trading. To gain this approval you will just need to fill out a quick online form and meet the criteria as set out by the broker that will place you into usually one of five stages.

As we mentioned, options contracts are made up of 100 shares which can be set with anywhere from a weekly to a quarterly expiry date (It varies).

When considering an option, look at two key prices to help you decide: The strike price and the premium price. For example, were you to buy a put option for Facebook at a $5 premium and a strike price of $130 (this means you will need to sell the shares for this price as soon as the expiry date hits if that is what you decide).

How Do I Sell a Put Option? 📉

When it comes to selling a put option, there are a few key things to keep at the top of your checklist. Firstly, it’s critical that you understand the value and profitability potential when it comes to an option contract’s value and profitability. Otherwise, you might put yourself at risk of the stock declining below any profitability potential.

Is Selling Put Options a Good Strategy? ✔️

The put seller, or writer of the option is under no obligation to hold the option up to the expiry date, and the same goes for the buyer of the option. When the price of the underlying stock moves in either direction, the premium for that option will reflect these movements.

The buyer of the option can sell the option in an effort to realize a profit, or reduce loss, depending on which way the price has moved.

In the same way, the writer of the option can do this too. If the price of the underlying asset is more than the strike price then you can simply not do a thing because the option might expire to $0, and then you can keep the premium. 

However, should the price of the underlying asset be moving closer down to beneath the strike price, in order to avoid a huge loss the seller might buy back the option which will get them out of that situation. The profit made or loss incurred is the premium you made minus the premium you paid to get out of that position.

The Bottom Line

Having done a thorough explanation of put options including how they work, how they can help you minimize risk and maximize bearishness, and key strategies to help protect you against stock market declines, we can see why put options have become the center of attention in the financial world today.

With brokers offering you direct access to options and at the lowest commission rates we’ve seen, you now have a powerful tool to help you on your investment journey, just like the pros.

Don’t just jump straight into it, take some time to learn the ins and outs of put options because, as powerful as they are, if they are used improperly, they can cause serious damage, too.