Skip to content

Knowledge

Okoora infrastructure Glossary

Understand core FX, risk, and execution concepts used across Okoora’s infrastructure.

Put Option

What is a Put Option?

A put option is a financial contract that gives the holder the right, but not the obligation, to sell an asset at a specified price (strike price) within a set period. It is commonly used for hedging or speculating on downward price movements.

How a Put Option Works

When an investor buys a put option, they pay a premium to obtain the right to sell an asset at a predetermined strike price. If the market price falls below the strike price, the investor can exercise the option to sell at the higher strike price, thus profiting from the price drop. If the market price stays above the strike, the option may expire worthless, and the loss is limited to the premium paid. Put options are often used to hedge against falling asset values or to speculate on a decline without short selling.

Put Option Example

Suppose an investor owns 100 shares of a stock priced at $150. To protect against a decline, they buy a put option with a $145 strike price for $4 per share ($400 total). If the stock drops to $130, they can sell at $145, limiting the loss on the stock to $5 (from $150 to $145) plus the $4 premium. Without the put, the loss would be $20 per share. Alternatively, a trader expecting a price drop might buy a put and profit if the asset falls below the strike price before expiration.

Key Concepts & Components

  • Strike Price: The price at which the option holder can sell the asset.
  • Expiration Date: The last date the option can be exercised.
  • Premium: The upfront cost of the option, paid by the buyer.
  • Intrinsic Value: The value gained if the option is exercised immediately (strike price – market price).
  • Time Value: The portion of the premium reflecting the probability of the asset dropping further before expiration.
  • Protective Put: A strategy used to hedge a long asset position by purchasing a put option.

When a Put Option Is Used

Put options are used in several ways:

  • To hedge against asset price declines
  • To speculate on market downturns with limited risk
  • As part of more advanced strategies, like spreads or married puts

They are vital for investors looking to reduce downside exposure while keeping potential upside intact. Traders may use them to profit from bearish outlooks without needing to short the asset directly.

Related Terms

References

Plain Vanilla OptionPipsPremium (Options)