What is a Put?

Put contracts are a directional speculative bet similar to a call contract. Buying a put is bearish (I think the underlying is going to go down) and selling a put is bullish (I think the underlying is going to go up). A bought put is referred to as a long put, a sold put is referred to as a short put.

 

Buying a put costs a debit and selling a put gives you a credit. When buying a put contract you have capped losses (the price of the contract), with almost infinite gains (the difference between the strike and 0). When selling a contract you have capped gains (the credit received), with finite losses (the difference between the strike and 0). 

 

Because they are contracts, there are rights and obligations involved with these transactions. If you buy a put contract, you have the right, but not the obligation, to sell 100 shares times the number of contracts at the strike price on the date of expiration. If you sell a put contract you have the OBLIGATION, not the right, to buy 100 shares times the number of contracts at the strike price on the date of expiration.   

 

Let’s see an example of this. You buy 1 put option on ticker X, with a strike of 15 expiring on the 15 of March for $1.00. Remember that each contract is a bundle of 100 shares so buying 1 contract @ $1.00 would cost you $100. The current share price of X is $20, so this contract is OTM. Let’s say on March 15 X is trading at $10. Nice job, you can exercise this contract to sell 100 shares at $15! Let’s say on March 15 X is trading at $25. No one wants to sell shares at $15 when they could sell them on the open market for $25, so this contract expires worthless. You have now lost your entry fee of $100.

 

Let’s use this same example but with selling a put option. If I speculate that the price won’t go below $15, I can sell a put at this strike. So I sell a put at the 15 strike and receive $100 of premium for that sale. If the stock goes down to $10 I am obligated to buy 100 shares at a price of $15. If the stock goes up to $25 I collect my premium and carry on with my day.

There are two ways to sell puts, cash-secured or naked. A cash-secured put means you secure your put sale with the amount of money needed to exercise the contract if it expires ITM. Let’s re-use our example from above. We sell a put at the 15 strike and receive $100 of premium for this sale. If this contract expires ITM we will have to put up $1400 to uphold our end of the contract ($1500 for 100 shares of X minus our $100 premium received). Selling a cash-secured put (CSP) decreases the risk of this position upon exercising.