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Put (Options Contract) – Definition
In an option contract, a put refers to a position in the contract that gives the owner the right to sell the underlying asset or security at the specified price, known as strike price within a set time. The owner of a put option is also known as the buyer, this is the party that has the right but not the obligation to sell the underlying asset. The price at which the buyer sells the underlying asset is a predetermined price reached before the exercise date. Once the owner or buyer of a put option decides to exercise his right to sell the underlying security, the seller or writer of the option contract is forced to purchase the security.
A Little More on What is a Put
A put option can have diverse underlying securities including commodities, stocks, currencies, and bonds. Buyers or owners of put options buy the option with the expectation that the value of the underlying security will decline below its exercise price before its expiration date. Taking such a position in a put option allows the buyer to exercise the right but not the obligation to sell the asset at a specific price.
Usually, in a put option, the value of the contract rises when the underlying asset declines in value, hence, the buyer of this option benefits from the decline in the value of the asset.
Puts and Calls
A call option is the opposite of a put option. Both put and call options are derivative contracts in the sense that their price movement is in the direction of the underlying asset. Put options and call options can be used for the trade of securities or assets, including stocks, bonds, and currencies.
In a call option, for instance, the holder of the option can exercise the right and not the obligation to buy a stock at a certain price before the expiration date. Traders of call option enter this position with the hope that the price of the underlying asset will increase within a period of time. In a put option, on the contrary, the holder expects to profit from the option when there is a decline in the price of the underlying asset.
Example of a Put Option
The illustration below will help you understand a put option better; An investor buyers a put option covering a number of shares of 100 with the belief that the shares will decline in value over a period of time. The exercise price of the underlying securities is $1.5 per share, making it a total of $150 for 100 shares. If the current price of the asset is $1.2 per share, the investor can decide to exercise the right but not the obligation to sell the assets.
Here are some important points you should know about a put option;
- A put option, simply put is a contract that gives a buyer or an owner the right but not the obligation to sell an underlying asset at a specific time before the expiration date.
- Investors or traders that buy put options anticipate a decline in the price of the underlying asset at a specific time.
- A put option increases in value when the price of the underlying asset declines and this contract decreases in value when the price of the underlying asset increase.