What are put options?
Put options are versatile financial instruments that can be used for hedging or speculation in US options and futures markets. Learn what put options are, how they work and the potential benefits they offer.
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Get info fast via our instant help and support portal. Available for account queries, ProRealTime, product info and more.
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Call 0800 409 6789 or email helpdesk.uk@ig.com if you have any questions about trading or investing. We're available 24/7 between 8am Saturday and 10pm Friday.
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The content on this page relates specifically to listed options, which can be traded using our US options and futures account.
What are put options?
Put options are financial contracts that give you the right, but not the obligation, to sell a specific asset (the underlying asset) at a predetermined price (the strike price) on or before a set date (the expiration date). They're often used as a form of insurance against potential price declines or for speculative options trading.
Note: for the sake of simplicity, on this page, we’ll focus on put options on equities (ie put options where the underlying asset is a stock), but keep in mind that other types of put options are available. Each standard equity options contract represents 100 shares of the underlying stock, and any explanations or examples given will use this as their basis.
Long put options profit from drops in an underlying’s price, while short put options benefit from a rise in the underlying’s price. Put options are essentially the opposite of call options, as they give the right to sell rather than buy the underlying asset.
Key characteristics of put options include:
The price at which the option holder can sell the underlying asset.
Expiration date
The last date by which the option can be exercised.
Premium
The upfront cost paid by the buyer to the seller for the options contract.
Think of buying options like taking out an insurance policy on your house. You pay a premium for the right to sell your house at a specific price (the strike price) within a certain time frame (on or before the expiration date). If your house is damaged, you’re protected. If it isn’t, you’re only out the premium you paid.
When you buy an option, you’re taking a long position. This applies to both put and call options. Long put options offer traders with a bearish market outlook the right to sell 100 shares at the strike price, with risk limited to the premium paid.
Long put options are profitable when they trade for more than the premium paid on entry. They provide leverage to control more shares with less capital, breaking even at the strike price minus the premium paid.
Short put options, suitable for traders with a bullish to neutral price outlook, involve the obligation to buy the underlying shares at the strike price if assigned. They offer immediate credit through the premium received and potential profit from time decay or lack of movement in the underlying’s price.
The maximum profit for short put options is limited to the premium received. Their breakeven point is calculated by subtracting the premium received from the strike price. Although the strategy carries substantial risk if the asset’s price falls to zero, the risk is limited.
How do put options work?
Put options work through an agreement between a buyer and a seller to exchange an underlying asset at a specific price by a set expiration date. You’ll often buy put options when you anticipate a significant drop in the underlying asset's price or an increase in implied volatility (IV) before the option expires. The setup of put options involves several key aspects:
Market speculation |
Leverage |
|
Put options attract different market outlooks. Buyers often anticipate a downward price movement, reflecting a bearish sentiment. In contrast, sellers usually expect the price to remain stable or potentially rise, indicating a neutral to bullish perspective on the underlying asset. |
Put options offer varying levels of risk for buyers and sellers. For buyers, they limit potential losses to the premium paid, unlike short-selling assets directly. For sellers, the maximum loss is calculated based on the asset’s price potentially dropping to zero. |
Options can provide exposure to larger positions with a smaller upfront outlay, depending on the trading account type. In margin accounts, this leverage is more pronounced, while in cash accounts, options are typically cash-secured, potentially limiting the leverage effect. |
Market speculation |
Leverage |
|
Put options attract different market outlooks. Buyers often anticipate a downward price movement, reflecting a bearish sentiment. In contrast, sellers usually expect the price to remain stable or potentially rise, indicating a neutral to bullish perspective on the underlying asset. |
Put options offer varying levels of risk for buyers and sellers. For buyers, they limit potential losses to the premium paid, unlike short-selling assets directly. For sellers, the maximum loss is calculated based on the asset’s price potentially dropping to zero. |
Options can provide exposure to larger positions with a smaller upfront outlay, depending on the trading account type. In margin accounts, this leverage is more pronounced, while in cash accounts, options are typically cash-secured, potentially limiting the leverage effect. |
There are three primary ways to settle long options contracts:
Exercise the option if it's in the money (ITM)
Sell the contract before expiry
Allow the option to expire worthless if it remains out of the money (OTM)
For short put options:
Be assigned if the option is exercised when it’s ITM
Buy back the contract before expiry
Let the option expire OTM, keeping the premium
The pricing of put options
Before we can get into buying and selling put options, it's helpful to know a bit more about how they're priced and what affects their value. Two main factors influence an option's price:
Intrinsic value: this is the amount by which an option is in the money. For a put option, it’s the difference between the strike price and the asset’s current price (if the asset’s price is below the strike price)
Extrinsic value (or time value): this is any additional value above the intrinsic value, based on the time left until expiration and the asset’s volatility
As the expiration date approaches, the extrinsic value decreases – also known as time decay. This is why options are often described as wasting assets.
Buying a put
Buying a put option, also known as going long on a put, is generally associated with a bearish market outlook. To profit from a long put position, the underlying asset's price needs to move significantly downward, crossing below the put's strike price before or on the expiration date.
Example:
Let’s say Tesla’s stock price is on the verge of dropping substantially. With its current price at $100, you think it’ll drop below $75 in the near term.
Suppose you buy a 45-day put option on Tesla stock with a strike price of $75 and a premium of $2 per share ($200 total for the contract). If the stock price falls below $73 (strike price minus the premium) by the expiration date, you can sell the contract at a higher premium for a net profit.
Even if the stock doesn't fall below the strike price, the put's value can increase if there's a sharp bearish move with ample time left before expiration. For instance, if the stock price drops to $65, you could potentially sell the contract for $10 intrinsic value ($75 - $65) plus any remaining extrinsic value.
If there's $1 of extrinsic value left, you could sell the contract for $11 per share ($1,100 total), resulting in a $900 profit ($1,100 - $200 initial premium).
A long put option can be closed in one of three ways:
Let it expire out of the money (OTM) and worthless, forfeiting the premium paid
Sell the put option for a profit in the money (ITM), or loss (if OTM) before expiration
Exercise the put and short 100 shares of the underlying asset (if ITM)
Selling a put
Selling put options, also known as writing puts or going short on puts, involves a neutral to bullish market outlook. Put sellers aim for the underlying asset's price to remain above the strike price, allowing them to keep the premium collected upfront as profit if the option expires out of the money.
Puts vs calls: what's the difference?
Put options and call options are like two sides of the same coin. Understanding the differences between them is crucial for any options trader.
Long put options |
Long call options |
Give the buyer the right to sell an underlying asset at a specific price |
Give the buyer the right to buy an underlying asset at a specific price |
Generate profit when the asset’s price falls |
Generate profit when the asset’s price rises |
Are used for bearish strategies or to hedge against downside risk |
Are used for bullish strategies |
Short put options |
Short call options |
May require the seller to buy an asset at a specific price |
May require the seller to sell the asset at a specific price |
Enable you to profit by keeping the premium you received if they remain OTM |
Enable you to profit by keeping the premium you received if they remain OTM |
Are used for a neutral to bullish market outlook |
Are used for a neutral to bearish market outlook |
Advantages and risks of trading put options
Put options can be a powerful tool in your trading toolkit, but they’re not for everyone. Understanding their potential advantages and disadvantages can help you avoid common mistakes.
Advantages:
Put options can protect investments against downside risk
You can control a large amount of stock with a relatively small capital outlay
Options can be used in various strategies to suit different market outlooks and risk tolerances
There’s potential for high returns as put options can provide significant returns if the underlying asset's price moves in a trader’s favour
Risks:
If the option expires out of the money, the entire premium paid is lost
Options are complex instruments and may be challenging to fully understand, especially for beginner traders
The value of options decreases as they approach expiration
Unexpected changes in implied volatility can negatively impact options prices
Selling options can result in major losses if the market moves sharply against a trader’s position
FAQs
Why would I sell a put option?
You might sell a put option if you’re neutral to bullish on an asset or want to generate an immediate profit.
When you sell a put, you collect a premium upfront. If the underlying market stays above the strike price, you keep this premium as profit.
Selling a put option is also a way to potentially buy an asset at a lower price than its current market value. However, remember that selling puts carries the risk of having to buy the asset at the strike price, even if it falls far below that level.
Can I buy a put option without owning the asset?
Yes, this is one of the advantages of put options. You can buy a put without owning the underlying asset, which is known as a long put. You’d use this strategy to speculate on a potential decrease in an asset’s price or to hedge against market downturns. It enables you to potentially profit from a falling asset price without the risks associated with short-selling.
How do I profit from buying a put option?
You profit when the underlying asset’s price falls below the strike price of your put option, minus the premium you paid. The further the asset’s price drops, the more valuable your put option becomes.
What's the maximum loss when buying a put option?
When buying a put option, your maximum loss is limited to the premium you paid for the option. This occurs if the asset’s price remains above the strike price at expiration.
What happens to my put option at expiration?
If the asset’s price is below the strike price at expiration, your put option is ‘in the money’ and you can exercise it to sell the asset at the higher strike price. If the asset’s price is above the strike price, the option expires worthless. Always check with your trading broker about their specific expiration procedures.
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