Beginner's Guide to Put Options

• Put options give buyers the right, but not the obligation, to sell shares of a stock at a preset "strike" price before the expiration date.
• Buyers make money if the stock falls below the strike price so they can buy shares cheaper and sell them for more via the option. Lose money if the stock stays above the strike price.
• Longer duration and higher strike prices make options more expensive but more potentially profitable. Short durations and lower strikes are cheaper.
• Entire option contracts represent 100 shares. Can buy multiple contracts to increase position size.
• Puts can be used to hedge and protect investments. Other strategies like cash-secured puts can generate income.

Put options provide a flexible way for investors to profit from falling stock prices or hedge their investments. This summary explains what put options are, when they are profitable, and key strategies for using them responsibly.

What Are Put Options?

A put option is a contract between a buyer and seller. The buyer pays a premium to acquire the right, but not the obligation, to sell 100 shares of an underlying stock to the seller at a preset "strike" price before an expiration date.

For example, a $40 put option on Stock XYZ gives the buyer the right to sell 100 shares of XYZ to the seller for $40 each before the expiration. The buyer hopes XYZ's price will fall below $40 so they can buy the shares cheaper on the open market and exercise the put to sell them for a profit.

Making Money With Puts

Buyers make money if the stock's price falls below the strike price. They can buy shares cheaper on the open market and sell them via the put for more than they paid. The more the price drops below the strike price, the more profit.

For example, if XYZ falls to $30 after buying a $40 put for $0.45 per share ($45 contract), the buyer could:

• Buy 100 XYZ shares for $30 each, or $3,000 total
• Exercise the put to sell those 100 shares for $40 each, receiving $4,000
• Profit is the $4,000 received minus $3,000 paid minus the $45 premium = $955

Losing Money With Puts

Buyers lose the premium paid if the stock stays above the strike price. There would be no reason to exercise the put in this case since shares can be sold for more on the open market.

For example, if XYZ only fell to $41 with the $40 put, it would be worthless. The buyer loses the $45 premium paid.

Key Factors That Impact Put Pricing

• Duration - Longer expiration dates mean higher premiums, but more time for the stock to potentially fall.
• Strike Price - Higher strike prices mean higher premiums, but the ability to sell the stock for more via the put.
• Volatility - Stocks with wider price swings command higher premiums due to greater profit potential.

Using Puts to Hedge Investments

Puts can help hedge investment risk. Put buyers profit from falling prices, offsetting losses on other long positions.

For example, an investor with a long position in XYZ could buy puts as "insurance." If XYZ falls, put profits offset declines in the XYZ shares.

Generating Income With Cash Secured Puts

Cash-secured puts involve selling, not buying, puts against cash reserves. This generates income from premiums as the seller hopes the put expires worthless.

For example, an investor with $4,000 cash could sell a $40 XYZ put for $45. If XYZ stays above $40, they keep the $45 premium. If XYZ falls below $40, they must buy the shares.

This strategy turns cash into potential income. However, sellers face risks if the stock falls sharply. Appropriate position sizing is key.

When used responsibly, put options provide investors with multiple opportunities to potentially profit from declining stock prices. However, it's critical to carefully weigh their risks and manage positions appropriately.