The buyer of a put option options the right, but not the obligation, to sell their stock at the pre-defined strike price prior to the option's expiration. This characteristic of the put option provides an opportunity to protect equity positions against capital loss and also allows us to take bearish positions in the market without taking on the trading risk of selling stock short. Because put options vest the buyer with the right to sell stock at a pre-determined price, these option contracts are frequently used to protected stock holdings from losses in the event of a stock decline. Much like insurance, a stock investor can pay a premium and purchase a put option to protect his holdings. In the event of a market downturn, he may sell the put option at an increased value to offset any losses or the option may be exercised, and the stock sold, at what would then be above market prices. He might simply sell his stock, but for various reasons this may not be desirable. It is not necessary to options stock before purchasing a put option. Because put options tend to increase in value when the underlying security falls in value, a put option is an excellent trading tool to utilize when trading want to act on a bearish market outlook. Expecting a drop in the current stock price of XYZ Company, we might consider selling the stock short. This can involve significant risk because if we are wrong about the direction of XYZ stock, we are exposed to unlimited risk to the upside. Even if we believe that the price increase is a momentary retracement, our short position exposes our risks to a potential margin call that would require us to close our position, sell other securities t adequately cover the risk of further upside price moves, or add cash to the account. Of course, none of these alternatives may be attractive. A put option allows us to avoid this dilemma entirely. Rather than selling stock short, we can simply buy a put option. Our risk is limited to the premium that we pay for the option contract no matter how high or low the stock price goes. As with a call option, buying a put option is a limited risk option strategy. The most you will ever lose on a put option purchase is the risks you paid to buy the option. Trading the other hand, your profits are not limited and will increase with a continued decline in the stock price. If you are following along with our option trading tutorial, we have now covered two stock option strategies. Buying a call option allows you to take a bullish position in the market and vests you with the right, but not the obligation, to buy the trading stock at a predefined price. The purchase of a put option allows you to take a bearish position in the market and can be used to protect stock holdings against a market sell off. If you have questions, be sure to avail yourself of the very knowledgeable people who frequent our stock option trading discussion board. Home Blog Member Login. Put Option Explained The put option may be used to protect a stock portfolio from losses, to profit from falling prices with limited trading risk, or to buy stock at below market prices. Using Put Options To Protect Stock Because put options vest the buyer with the right to sell stock options a pre-determined price, these option contracts are frequently used to protected stock holdings from losses in the event stock a market decline. Put Options As Speculative Trading Instruments It is not necessary to own stock before purchasing a put option. Risk Profile For A Long Put Option As with a call option, buying a put option is a limited risk option strategy. About The Author Christopher Smith. Remember me Lost your password? Disclaimers Privacy Policy Risks and Conditions of Use.
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