What Is a Put Option? A Beginner's Guide to Buying Puts

A put option is a contract that gives you the right, but not the obligation, to sell an asset at a specific price within a set time period. Put options are one of the two basic types of options—the opposite of call options—and understanding them is essential for anyone looking to trade options or protect their portfolio.

In this guide, I'll explain put options using a simple real-world analogy, then show you how they work with actual stock examples. By the end, you'll understand when and why traders buy put options, whether for protection or profit.

Understanding Put Options: The Laptop Analogy

I have a nice Apple laptop with all the bells and whistles that I paid up for in part because Apple products are known to have good resale value. I plan to retire within a year (woot!) and because I will not need the laptop anymore I hope to sell it and recoup most of my money. My target is to sell the laptop for 80% of the price I paid for it—but I am afraid that Apple might release a new line of laptops, which would accelerate my laptop's value decline such that I could only get 50% or less.

I consult with my investor friend Tim and he does not think a new line of laptops is likely in the next year. Though Tim believes I am safe, I am still not sure and wonder if there is a way to protect myself.

It turns out that Tim is very confident in his prediction and sees an opportunity to make some money, so he offers me a deal: if I pay him a $100 fee today, he will buy the laptop from me anytime in the next year for $1,600—or 80% of the $2,000 I paid. This deal (or contract) is called a put option, and it gives me the right to sell something at a set price in the future in exchange for a fee.

In options trading terminology:

• The $100 fee is called the premium
• The $1,600 guaranteed sale price is called the strike price
• The 1-year deadline is called the expiration date
• The laptop is called the underlying asset

The Put Option Details: How It Plays Out

Tim is betting that the value of the laptop will not drop by 20% within the next year. Let's look at different scenarios:

Scenario 1: The Laptop Holds Its Value

If the value drops by only 10% to $1,800, I will choose not to exercise my put option to sell the laptop to Tim for $1,600 because I can sell it to someone else for $1,800. I would, however, lose the $100 I paid Tim—which he would pocket as profit—and our put option would expire worthless.

Scenario 2: The Laptop Loses Significant Value

But what if Tim is wrong and Apple does announce a new line of laptops? Overnight the value of my laptop might drop by 50% to $1,000. The good news is that because I have a put option contract with Tim, he would be obligated to buy it from me for $1,600—which is $600 more than it is worth. My total profit from having the put option would be $500 ($600 extra I received minus the $100 premium I paid).

How Put Options Work with Stocks

In the stock market, put options work the same way but with stocks instead of laptops. When you buy a put option on a stock like Apple (AAPL), you're paying a premium for the right to sell 100 shares at a specific strike price before the expiration date.

For example, let's say you own 100 shares of Apple trading at $150 per share. You're worried about a market downturn, so you buy a put option with:

• Strike price: $140
• Expiration: 60 days from now
• Premium: $4.00 per share ($400 total, since each contract controls 100 shares)

This gives you the right to sell your 100 shares at $140, no matter how low the stock price goes. If Apple drops to $100 during a market crash, you could exercise your put and sell at $140—limiting your loss and protecting your portfolio.

Why Do Traders Buy Put Options?

There are three main reasons traders buy put options:

1. Portfolio Protection (Hedging)

If you own stocks and want to protect against a potential decline, buying puts is like buying insurance. You pay a premium, and if the worst happens, you're protected. This is especially popular before earnings announcements, elections, or other events that could cause volatility.

2. Speculation on Price Declines

If you believe a stock is going to fall but don't want to short sell (which has unlimited risk), put options provide a way to profit from a decline with limited downside. Your maximum loss is the premium you paid.

3. Income Generation

More advanced traders sell put options to collect premium income, betting that the stock won't fall below the strike price. This is how put credit spreads work—a strategy I use extensively for monthly income.

Put Option Example: Profitable Trade

Let's walk through a profitable put option trade:

1. You're bearish on XYZ stock, currently trading at $50
2. You buy a put option with a $45 strike price for $2.00 per share ($200 total)
3. Bad news hits and XYZ drops to $35
4. Your put option is now worth at least $10 ($45 strike - $35 stock price), or $1,000 per contract
5. You sell the put for $1,000, making a profit of $800 (a 400% return on your $200 investment)

Put Option Example: Losing Trade

Now let's see how a put option trade can go wrong:

1. You're bearish on XYZ stock, currently trading at $50
2. You buy a put option with a $45 strike price for $2.00 per share ($200 total)
3. XYZ releases great earnings and rises to $60
4. Your put option expires worthless because XYZ never fell below $45
5. You lose your entire $200 premium—a 100% loss

This illustrates why options trading requires skill and timing. You can lose 100% of your investment if the stock doesn't move in your favor.

Key Terms for Put Option Traders

Here are the essential terms you need to know:

• In the money (ITM): When the stock price is below the strike price. For puts, this means you can sell higher than market value.
• Out of the money (OTM): When the stock price is above the strike price. These puts are cheaper but less likely to be profitable.
• At the money (ATM): When the stock price equals the strike price.
• Protective put: Buying a put on a stock you already own to protect against losses (like insurance).
• Naked put: Selling a put without owning the underlying stock—a strategy with significant risk.
• Exercise: Using your right to sell the stock at the strike price.

Puts vs. Calls: Key Differences

Understanding the difference between puts and calls is fundamental:

Common Put Option Strategies

Beyond simply buying puts, there are several strategies that incorporate put options:

• Protective Put: Buy a put on stock you own to limit downside risk
• Married Put: Buy stock and a put simultaneously as a combined position
• Put Credit Spread: Sell a put and buy a lower-strike put to collect premium with limited risk
• Cash-Secured Put: Sell a put with enough cash to buy the stock if assigned—a way to potentially acquire stocks at a discount

Should You Trade Put Options?

Put options can be valuable tools for both protection and profit, but they require education and practice:

• For protection: If you have a significant stock portfolio, learning to use protective puts can help you sleep at night during volatile markets.
• For income: Selling puts (carefully, with proper risk management) can generate consistent income—this is the foundation of many successful options trading strategies.
• For speculation: Buying puts to bet on stock declines is risky and requires good timing and market analysis.

Next Steps

Now that you understand put options, here are some related topics to explore:

• What Is a Call Option? - Make sure you understand the other fundamental option type
• What Is a Put Credit Spread? - Learn about this popular income-generating strategy
• Baseline Strategy for Trading SPY Put Credit Spreads - See how I use puts to generate monthly income
• How Does Volatility Affect Option Prices? - Understand this crucial pricing factor

Options trading can be complex, but understanding puts and calls is the foundation. Once you master these basics, you can explore more sophisticated strategies that combine multiple options for different risk/reward profiles.

Related Topics: Put Options, Options Basics, Options Trading, Buying Puts, Options for Beginners, Hedging