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Puts are a type of financial instrument known as options

What are puts?

Puts are a type of financial instrument known as options. They give you the right, but not the obligation, to sell a specific stock at a predetermined price within a certain period of time. Puts are commonly used by investors and traders to protect their portfolios from potential losses or to profit when the price of a stock goes down.

Key takeaways

- Puts are options that allow you to protect your stock investments or potentially profit from a declining stock price.
- They give you the right to sell a stock at a predetermined price, providing insurance against losses or opportunities for gains.
- Puts can be a valuable tool for managing risk and taking advantage of market movements.
- It's important to understand the risks involved and consider professional advice before engaging in options trading.

How do puts work?

When you buy a put option, you are essentially purchasing insurance for your stocks. If you own shares of a company and you're worried that the stock price might drop, you can buy a put option to protect yourself. If the stock price does fall, you can exercise the put option and sell your shares at the predetermined price, even if the market price is lower.

Puts in the real world

Let's say you own 100 shares of XYZ Company, which is currently trading at $50 per share. Worried that the stock might decline, you buy a put option with a strike price of $45 and an expiration date of one month. This means that within the next month, you have the right to sell your XYZ shares for $45 each, regardless of the current market price. If the stock falls to $40, you can exercise your put option and sell your shares for $45, limiting your losses.

On the other hand, if you believe that a stock will decline in value and you don't own it, you can still profit from the price drop by selling puts. When you sell a put option, you collect a premium upfront. If the stock price stays above the strike price until the expiration date, you keep the premium as profit. However, if the stock price falls below the strike price, the buyer of the put option can exercise it, and you will be obligated to buy the stock at the strike price.