Buy Put Options
The Insurance Policy
Learn how to use put options as a protective strategy against market downturns or to profit from anticipated price declines while maintaining limited risk.
Strategy Overview
When you buy a put option, you're purchasing the right (but not the obligation) to sell 100 shares of a stock at a specific price (strike price) until a certain date (expiration). This strategy serves two main purposes: protecting existing stock positions from downside risk or profiting from anticipated price declines.
Premium
The cost you pay for the option. This is your maximum potential loss and the price of your "insurance."
Strike Price
The price at which you can sell the stock. Think of this as your insurance coverage level.
Expiration Date
The last day you can exercise your option. Like insurance, protection lasts until this date.
Break-Even Point
Strike price minus premium paid. Stock must fall below this for profit.
Payoff Diagram
When to Use This Strategy
Portfolio Protection
When you want to protect existing stock positions against potential market downturns or increased volatility.
Bearish Outlook
When you expect a stock or market decline and want to profit from the downward movement with limited risk.
Event Risk
When approaching significant events (earnings, FDA decisions, etc.) that could negatively impact stock price.
Example Trade
Let's examine two scenarios using put options:
Trade Setup
- Stock: XYZ trading at $100
- Action: Buy 1 put option
- Strike Price: $95
- Premium: $2.50 ($250 total for 1 contract)
- Expiration: 45 days
- Break-even: $92.50 ($95 - $2.50)
Potential Outcomes
Profitable Scenario
Stock falls to $85:
- Intrinsic value: $10 ($95 - $85)
- Profit: $7.50 per share ($10 - $2.50 premium)
- Total profit: $750 per contract
Loss Scenario
Stock rises to $105:
- Option expires worthless
- Loss: Premium paid
- Total loss: $250 per contract
Strategy Quick Facts
Maximum Loss
Limited to premium paid
Maximum Profit
Strike price - premium (stock can't go below zero)
Break-even Point
Strike price - premium paid
Time Decay Impact
Negative (hurts position)
Implied Volatility Impact
Positive when rising
Risk Management
Common Mistakes to Avoid
Overpaying for Protection
Buying puts when implied volatility is high can make protection extremely expensive. Consider the cost-benefit ratio.
Strike Selection Mistakes
Choosing strikes too far OTM for portfolio protection may not provide adequate coverage when needed most.
Ignoring Time Decay
Holding long puts through periods of low volatility and sideways markets can erode their value quickly.
Poor Position Sizing
Either over-hedging (too many puts relative to portfolio) or under-hedging (insufficient protection) can lead to suboptimal outcomes.
Ready to Practice Put Options?
Master protective put strategies through our interactive tools: