Put Option

There are basically only two types of options: call options and put options.

A put option gives the holder the right but not the obligation to sell a certain stock (underlying security) at a certain price (strike price) by a certain date (expiration date).

Example: Suppose you own 100 shares of The XYZ Zipper Company and it's trading at $40/share. If you believe the stock to be at risk of falling in the near term, you could purchase a put to give yourself some protection.

Let's suppose that you decide to purchase a put option expiring in one month at the $35 strike price for $1 (multiplied by 100 shares = $100). You now have the right, but not the obligation, to sell your stock for $35/share between now and expiration.

If the stock stays above $35/share, your put expires worthless and you keep your stock. If, however, the stock does take a dive, your purchase of the put guarantees that you will still be able to get out at the strike price of $35/share no matter how low the stock itself trades.

The above is an example of a protective put, a hedging strategy designed to protect your holdings from big declines. But there is no requirement that you own the underlying stock in order to purchase a put, and, in fact, most purchasers of puts don't own the stock.

Most buyers of puts are simply betting that a stock will fall in price because, all else being equal, when a stock tumbles, the value of its corresponding puts increase (see table below).

The same is true with calls. Most traders who buy calls or puts aren't purchasing them with any intention of exercising them.

On the contrary, they're betting that the value of the individual option will increase in the near future (e.g. call buyers are betting the stock will go up and put buyers are betting that the stock will go down). They don't buy options to exercise them, but rather to sell them for a profit.