When a trader buys a put option contract, they buy the chance to create a short-sale of a stock at the strike price. Selling short allows a trader to profit when stocks go down.

A put option contract gives a trader the right to take that kind of chance. They can sell short if they want, or they can let the contract expire. As with call option traders, most put option traders try to benefit from the change in the option price itself. Let’s take a closer look at how that happens.

Suppose a trader buys a put option on XYZ stock with a strike price of $98. Let’s also suppose that at the time of purchase, the option has 30 days left until it expires. The setup might look something like this…

The 98 put option contract costs $1.00 per share. This implies that the trader would spend $100 dollars to buy the contract. That’s because the contract includes the chance to sell short 100 shares of XYZ. Traders may choose to buy a put option with a strike price below the current price of the stock. If they do, and then the stock price moves lower, they can benefit from this move if it happens quickly enough.

Consider this scenario where XYZ might fall to $98. The original cost of the option was only $1.00, but when the stock dropped, the value of the option rose. 

In this scenario the put option buyer now has two alternatives. The first alternative is: exercise the option. That would give the trader a short position on XYZ starting from $98 per share. 

The second alternative is to simply sell the put option, and get the benefit from the increased value of the contract. In this example it would create a net profit of $110 before commissions. 

It is true that most traders would hope for a stronger downward move. Here is what that might look like. 

In this scenario the put option price has moved to $4.70 per share because XYZ fell to $94.25. The move of the stock is the biggest influence on the price. This stronger move lower means the option value increases more dramatically. If the put option buyer simply sells the option now (rather than exercising it) they give someone else the chance to sell XYZ short at $98 and they receive $470 for doing so. That means the net profit from the trade is $370.  This outcome, or something even better, is what every put option buyer hopes for. 

On the other hand, option traders must be aware of the risks they take. The stock can always move against them. In this example let’s consider what would happen to the put option if the share price rose instead of falling. 

If XYZ traded as high as $103 dollars two weeks later, it could create a scenario where the price of the put option falls. In that scenario the put option might be priced as low as $.40, losing more than half its value. 

When a put option trade doesn’t work as hoped, it happens because the price of the stock moves higher. The value of a put option increases when the price of the stock drops and decreases when the stock price rises. 

Buying put options offers a way to capture the opportunity, behind a downward move in a stock price, while maintaining a limited amount of risk. 

In summary, buying a put option allows a trader a chance of shorting a stock if they choose to do so. The cost for having that chance is the price of the option. If the stock moves favorably, they can benefit by exercising the option or by selling the option to someone else. 

If the stock moves unfavorably, they will lose some or all of the money they used to purchase the option, but their risk is limited to that amount of loss.

Once a trader understands the basics behind how buying options works, it becomes important to see the opposite approach to options–that of being an option seller. The next part of the Beginner’s Guide discusses the two opposing approaches to option trading: buying and selling.

When a trader buys a put option contract, they buy the chance to create a short-sale of a stock at the strike price. Selling short allows a trader to profit when stocks go down.

A put option contract gives a trader the right to take that kind of chance. They can sell short if they want, or they can let the contract expire. As with call option traders, most put option traders try to benefit from the change in the option price itself. Let’s take a closer look at how that happens.

Suppose a trader buys a put option on XYZ stock with a strike price of $98. Let’s also suppose that at the time of purchase, the option has 30 days left until it expires. The setup might look something like this…

The 98 put option contract costs $1.00 per share. This implies that the trader would spend $100 dollars to buy the contract. That’s because the contract includes the chance to sell short 100 shares of XYZ. Traders may choose to buy a put option with a strike price below the current price of the stock. If they do, and then the stock price moves lower, they can benefit from this move if it happens quickly enough.

Consider this scenario where XYZ might fall to $98. The original cost of the option was only $1.00, but when the stock dropped, the value of the option rose. 

In this scenario the put option buyer now has two alternatives. The first alternative is: exercise the option. That would give the trader a short position on XYZ starting from $98 per share. 

The second alternative is to simply sell the put option, and get the benefit from the increased value of the contract. In this example it would create a net profit of $110 before commissions. 

It is true that most traders would hope for a stronger downward move. Here is what that might look like. 

In this scenario the put option price has moved to $4.70 per share because XYZ fell to $94.25. The move of the stock is the biggest influence on the price. This stronger move lower means the option value increases more dramatically. If the put option buyer simply sells the option now (rather than exercising it) they give someone else the chance to sell XYZ short at $98 and they receive $470 for doing so. That means the net profit from the trade is $370.  This outcome, or something even better, is what every put option buyer hopes for. 

On the other hand, option traders must be aware of the risks they take. The stock can always move against them. In this example let’s consider what would happen to the put option if the share price rose instead of falling. 

If XYZ traded as high as $103 dollars two weeks later, it could create a scenario where the price of the put option falls. In that scenario the put option might be priced as low as $.40, losing more than half its value. 

When a put option trade doesn’t work as hoped, it happens because the price of the stock moves higher. The value of a put option increases when the price of the stock drops and decreases when the stock price rises. 

Buying put options offers a way to capture the opportunity, behind a downward move in a stock price, while maintaining a limited amount of risk. 

In summary, buying a put option allows a trader a chance of shorting a stock if they choose to do so. The cost for having that chance is the price of the option. If the stock moves favorably, they can benefit by exercising the option or by selling the option to someone else. 

If the stock moves unfavorably, they will lose some or all of the money they used to purchase the option, but their risk is limited to that amount of loss.

Once a trader understands the basics behind how buying options works, it becomes important to see the opposite approach to options–that of being an option seller. The next part of the Beginner’s Guide discusses the two opposing approaches to option trading: buying and selling.