# Put option

__NOTOC__

A put option (sometimes simply called a "put") is a financial contract between two parties, the seller (writer) and the buyer of the option. The put allows its buyer the "right but not the obligation" to sell a commodity or financial instrument (the underlying instrument) to the writer (seller) of the option at a certain time for a certain price (the strike price). The writer (seller) has the obligation to purchase the underlying asset at that strike price, if the buyer exercises the option.

Note that the writer of the option is agreeing to "buy" the underlying asset if the buyer exercises the option. In exchange for having this option, the buyer pays the writer (seller) a fee (the premium). (Note: Although option writers are frequently referred to as sellers, because they initially sell the option that they create, thus taking a long position in the option, they are not the only sellers. An option holder can also sell his short position in the option. However, the difference between the two sellers is that the option writer takes on the legal obligation to buy the underlying asset at the strike price, whereas the option holder is merely selling his long position, and is not contractually obligated by the sold option.)

Exact specifications may differ depending on option style. A European put option allows the holder to exercise the put option for a short period of time right before expiration. An American put option allows exercise at any time during the life of the option.

The most widely-known put option is for stock in a particular company. However, options are traded on many other assets: financial - such as interest rates (see interest rate floor) - and physical, such as gold or crude oil.

The put "buyer" either believes it's likely the price of the underlying asset will fall by the exercise date, or hopes to protect a long position in the asset. The advantage of buying a put over shorting the asset is that the risk is limited to the premium. The put "writer" does not believe the price of the underlying security is likely to fall. The writer sells the put to collect the premium. Puts can also be used to limit portfolio risk, and may be part of an option spread.

Example of a put option on a stock

Buy a Put: A Buyer thinks price of a stock will decrease. Pay a premium which buyer will never get back, unless it is sold before expiration. The buyer has the right to sell the stock at strike price.

*'Trader A' (Put Buyer) purchases a put contract to sell 100 shares of XYZ Corp. to 'Trader B' (Put Writer) for \$50/share. The current price is \$55/share, and 'Trader A' pays a premium of \$5/share. If the price of XYZ stock falls to \$40/share right before expiration, then 'Trader A' can exercise the put by buying 100 shares for \$4,000 from the stock market, then selling them to 'Trader B' for \$5,000.

Trader A's total earnings (S) can be calculated at \$500. Sale of the 100 stock at strike price of \$50 to 'Trader B' = \$5,000 (P) Purchase of 100 stock at \$40 = \$4,000 (Q) Put Option premium paid to Trader B for buying the contract of 100 shares @ \$5/share, excluding commissions = \$500 (R) S=P-(Q+R)=\$5,000-(\$4,000+\$500)=\$500

*If, however, the share price never drops below the strike price (in this case, \$50), then 'Trader A' would not exercise the option. (Why sell a stock to 'Trader B' at \$50, if it would cost 'Trader A' more than that to buy it?). Trader A's option would be worthless and he would have lost the whole investment, the fee (premium) for the option contract, \$500 (5/share, 100 shares per contract). Trader A's total loss are limited to the cost of the put premium plus the sales commission to buy it.

This example illustrates that the put option has positive monetary value when the underlying instrument has a spot price (S) "below" the strike price (K). Since the option will not be exercised unless it is "in-the-money", the payoff for a put option is

:max [("K" − "S") ; 0] or formally, $\left(K-S\right)^\left\{+\right\}$ :where :

Prior to exercise, the option value, and therefore price, varies with the underlying price and with time. The put price must reflect the "likelihood" or chance of the option "finishing in-the-money". The price should thus be higher with more time to expiry, and with a more volatile underlying instrument. Determining this value is the central problem of financial mathematics. The most common method is to use the Black-Scholes formula. Whatever the formula used, the buyer and seller must agree on this value initially.

ee also

*Put Option Investigations Following 9/11
*Call option

Options

*Credit default option
*Interest rate cap and floor
*Options on futures
*Real option

* [http://basicoptionstrading.com/ Basic options techniques] , tutorial on long puts for beginners
* [http://www.defenseindustrydaily.com/2006/09/bae-exercising-its-put-option-re-airbus/index.php BAE Exercising Its 'Put Option' Re: Airbus]
* [http://shabbir.in/call-and-put-options/ Call and Put Options]

Wikimedia Foundation. 2010.

### Look at other dictionaries:

• put option — see option 3 Merriam Webster’s Dictionary of Law. Merriam Webster. 1996. put option …   Law dictionary

• put option — put or put option Fin an option to sell stock within a specified time at a specified price …   The ultimate business dictionary

• Put-Option — Payoff eines Puts zum Laufzeitende t=T; Hockeystick Funktion Auszahlungsstruktur einer Put Option abhängig vom Preis des Basiswertes am Laufzeitende. Eine Put Option …   Deutsch Wikipedia

• Put Option — Payoff eines Puts zum Laufzeitende t=T; Hockeystick Funktion Auszahlungsstruktur einer Put Option abhängig vom Preis des Basiswertes am Laufzeitende. Eine Put Option …   Deutsch Wikipedia

• put option — An option that gives the option buyer the right but not the obligation to sell ( go short ) the underlying futures contract at the strike price on or before the expiration date. Chicago Board of Trade glossary This security gives investors the… …   Financial and business terms

• Put option — This security gives investors the right to sell (or put) fixed number of shares at a fixed price within a given time frame. An investor, for example, might wish to have the right to sell shares of a stock at a certain price by a certain time in… …   Financial and business terms

• Put Option — An option contract giving the owner the right, but not the obligation, to sell a specified amount of an underlying security at a specified price within a specified time. This is the opposite of a call option, which gives the holder the right to… …   Investment dictionary

• put option — pasirinkimo parduoti sandoris statusas Aprobuotas sritis buhalterinė apskaita ir finansinė atskaitomybė apibrėžtis Sandoris, pagal kurį už tam tikrą mokestį įsigyjama teisė, bet ne įsipareigojimas ateityje už nustatytą kainą parduoti prekes,… …   Lithuanian dictionary (lietuvių žodynas)

• put option — put′ op tion n. Finance. ste bus put 37) …   From formal English to slang

• put option — noun 1. an option to sell • Hypernyms: ↑stock option 2. the option to sell a given stock (or stock index or commodity future) at a given price before a given date • Syn: ↑put • Ant: ↑call option • Hy …   Useful english dictionary