What is a put option?

A put option, or put, is a contract that gives you the right, but not the obligation, to sell the underlying investment at a specific price, called the strike price, before the option expires. The price of a put is called the premium, which fluctuates depending on a number of factors, including the current stock price and the time left until the expiration date.

Most options are “American” options, meaning you can exercise them at any time up until the expiration date. “European” options are less common and can only be exercised on the expiration date.

Investors buy puts when they expect the price of the underlying stock to decrease. The put allows them to sell a specific number of shares, usually 100, at the strike price, regardless of the current market price. (When investors expect the price of a stock to increase, they can buy a call option, which gives them the right, but not the obligation, to buy a specified number of shares at a predetermined strike price by the option’s expiration date.)

If you own shares in a company and you’re worried about a major price decline, you can buy puts to protect your investment. If the price falls from $200 to $100, for example, a put with a $150 strike price will allow you to sell your stock for $150 instead of the current market price of $100. This limits your loss. 

People also buy puts to speculate on future declines in the prices of stocks they do not own.

With a put, your risk is limited to the premium you pay. If the stock declines, you can exercise your put and profit on the change in price. If not, you can sell it or allow it to expire worthless.

Example: “Worried about a market crash, Beulah bought puts on the S&P/TSX 60 Composite Index, hoping to profit from the decline.”

Read more about options:

• What you need to know about options
  If the recent GameStop drama has piqued your interest, this guide gives you the basics on what options are, how they work, the potential rewards—and significant risks.
• Enhancing your equity income with ETFs
  How to use enhanced income ETFs, as well as dividend and REIT ETFs to provide a steady stream of cash flow for expenses or retirement.
• What is a call option? What should retirees care about them?
  Call options are a type of financial contract that investors can buy and sell. Here’s how they can help generate income even when markets are volatile.

• Questrade vs. Wealthsimple: Which online investing service is right for you?
  We dug into the differences between these seemingly similar online investing services to help you decide which one is for you.

About MoneySense Editors

MoneySense editors and journalists work closely with leading personal finance experts in Canada. Since 1999, our award-winning magazine has helped Canadians navigate money matters.

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