What Is A Put?
A put is an option which gives the owner the right, but not the obligation, to buy an asset at a pre-determined price within a given time period.
An investor would buy a put option on an asset when they believe it is going to increase in price.
An example of how a put option works is as follows:
- On October 1st, the stock price of Morgan Stanley is $15
- The cost of a December put with a strike price of $10 is $2
- The total cost of the contract is $2 x 100 = $200
- The breakeven point is $8 per share (10-2)
- On November 1st, the stock price of Morgan Stanley is $17
- This is less than the strike price so the option is worthless and the current loss is $200
- On December 1st the stock price of Morgan Stanley is $3
- The profit on the put option is ((10-2-3) x 100) = $500
- The maximum loss on the option is always $200 (the lowest it can be valued is 0) but the maximum profit is ((15-2-0) x 100) = $1300 and the starting investment is very small
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