Puts
The right to sell. Useful as insurance on something you own, and as a way to profit from a fall.
A put is the mirror of a call. It is the right to sell something at a fixed price, on or before a fixed date.
Back to the shop. This time you already own the bicycle, and you are worried the price might collapse. You pay the shopkeeper £10 for a promise that he will buy it from you for £200 any time in the next three months, whatever has happened to the price.
If the price crashes to £100, your promise is valuable — you can still sell at £200. If the price rises to £300, you ignore the promise and your £10 was the cost of sleeping well.
That is insurance
You pay a premium. If the bad thing happens you are compensated. If it does not, the premium is gone and you are not sorry. Nobody complains that their house did not burn down.
This is the least controversial use of options and the one that most resembles what insurance is for. It has a name: a protective put.
The other use
You can also buy a put on something you do not own, purely because you think the price will fall. Same contract, entirely different purpose — speculation rather than protection.
| Share price at expiry | Is the right useful? | Value of the option | Your result |
|---|---|---|---|
| $110 | No — you could sell higher | $0 | −$3 |
| $90 | No better than the market | $0 | −$3 |
| $87 | Yes, by $3 | $3 | $0 — break even |
| $70 | Yes, by $20 | $20 | +$17 |
The limit on a put
A share can rise without limit, so a call's possible gain is open-ended. A share can only fall to zero, so a put's maximum value is the strike price. That asymmetry matters when you compare what the two are worth.
Why puts often cost more than you expect
Because more people want them. Falls tend to be faster and more frightening than rises, and demand for protection rises exactly when everyone wants it at once. You will meet this again as implied volatility.