A put option is a type of financial instrument known as a derivative. It is basically an agreement between parties to exchange ownership of a stock at an agreed upon price within a certain time period. The exchange of the stock is optional and the owner of the put option decides whether it takes place.

The agreed upon price of the exchange is called the strike price. The date on which the put option expires is the expiry date. The amount of money required to purchase this put option is called the premium. If the exchange takes place, then one is said to have exercised the put option.

Put option premiums are always quoted per stock, but sold in lots of 100 shares minimum. Put options are always an agreement about being able to sell the stock at the agreed upon price. Put options come in both European style and American style.

European style put options are sold on European exchanges, while American style put options are sold in North American exchanges. The difference is quite simple. European options can only be exercised on the expiry date, while American style options can be exercised at any time during the life of the put option.

There are two investment styles when investing in put options. Conservative investors purchase a put option on stock that is part of their portfolio as an insurance policy against a large drop in the price of the stock. For example, if a conservative investor owns stock in company XYZ and is concerned that the stock price may decline, but is unwilling to sell the stock in XYZ, a put option can be purchased to insure that if XYZ stock were to dramatically decline in price, the investor would be able to sell the stock at the strike price of the put option. If XYZ stock is selling at 45 US dollars (USD), a put option could be purchased with a strike price of 43 USD.

At any time during the life of the put option, the owner may sell XYZ stock for 43 USD per share. This would only be done if the price of the XYZ share were to fall below 43 USD. The price of this put option will be dependant upon a number of variables but will be much less then 43 USD, typically in the 1 to 2 USD range. This example assumes an American style put option. Remember also that put options can only be purchased in lots of 100 shares.

The speculative put option investor either purchases or sells put options without owning the underlying stock. Selling a put option is also called "writing" a put option, and the seller of the put option is said to be its writer. If a speculative investor thinks XZY stock is going to increase in value, then the investor will be a writer or seller of put options. When the stock price of XYZ company increases in value, the put options decrease in value. If a speculative investor thinks XZY stock is going to decrease in value, then the investor will be a buyer of put options. When the stock price of XYZ company decreases in value, the put options increase in value.

The use of put options allows the speculative investor to dramatically increase the profit earned compared to making purchases in the stock or company itself due to the leverage that is built into the put option. For example, if the investor thinks XYZ stock currently selling for 45 USD per share is likely to decline to 43 USD per share, a put option with a 45 USD strike could be purchased for close to 1 USD. If the price does in fact decline to 43 USD, the put option value will increase in value to 2 USD or possibly even more. However, if the XYZ stock price does not decline as expected, then the investor will lose the entire amount invested.