A put or put option is a contract between two parties to exchange an asset (the underlying), at a specified price (the strike), by a predetermined date (the expiry or maturity). One party, the buyer of the put, has the right, but not an obligation, to sell the asset at the strike price by the future date, while the other party, the seller of the put, has the obligation to buy the asset at the strike price if the buyer exercises the option.
If the strike is K and maturity time is T, and the buyer exercises the put at a time t, the buyer can expect to receive a payout of K-S(t), if the price of the underlying S(t) at that time is less than K. The exercise t must occur by time T; precisely what exact times are allowed is specified by the type of put option. An American option can be exercised at any time before or equal to T; a European option can be exercised only at time T; a Bermudan option can be exercised only on specific dates listed in the terms of the contract. If the option is not exercised by maturity, it expires worthless. (Note that the buyer will not exercise the option at an allowable date if the price of the underlying is greater than K.)
The most obvious use of a put is as a type of insurance. In the protective put strategy, the investor buys enough puts to cover their holdings of the underlying so that if a drastic downward movement of the underlying's price occurs, they have the option to sell the holdings at the strike price. Another use is for speculation: an investor can take a short position in the underlying without trading in it directly.
Puts may also be combined with other derivatives as part of more complex investment strategies, and in particular, may be useful for hedging. Note that by put-call parity, a European put can be replaced by buying the appropriate call option and selling an appropriate forward contract.
Read more about Put Option: Instrument Models, Example of A Put Option On A Stock, Payoff of A Put
Famous quotes containing the words put and/or option:
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“Our passional nature not only lawfully may, but must, decide an option between propositions, whenever it is a genuine option that cannot by its nature be decided on intellectual grounds; for to say, under such circumstances, “Do not decide, but leave the question open,” is itself a passional decision—just like deciding yes or no—and is attended with the same risk of losing the truth.”
—William James (1842–1910)