how a put option works
a put option becomes more valuable as the price of the underlying stock or security decreases conversely a put option loses its value as the price of the underlying stock increases as a result they are typically used for hedging purposes or to speculate on downside price action investors often use put options in a risk management strategy known as a protective put which is used as a form of investment insurance or hedge to ensure that losses in the underlying asset do not exceed a certain amount in this strategy the investor buys a put option to hedge downside risk in a stock held in the portfolio if and when the option is exercised the investor would sell the stock at the put s strike price if the investor does not hold the underlying stock and exercises a put option this would create a short position in the stock in general the value of a put option decreases as its time to expiration approaches because of the impact of time decay time decay accelerates as an option s time to expiration draws closer since there s less time to realize a profit from the trade when an option loses its time value the intrinsic value is left over an option s intrinsic value is equivalent to the difference between the strike price and the underlying stock price if an option has intrinsic value it is referred to as in the money itm option intrinsic value difference between market price of underlying security and option strike price for put option iv strike price minus market price of underlying security for call option iv market price of underlying security minus strike price out of the money otm and at the money atm put options have no intrinsic value because there is no benefit in exercising the option investors have the option of short selling the stock at the current higher market price rather than exercising an out of the money put option at an undesirable strike price however outside of a bear market short selling is typically riskier than buying put options time value or extrinsic value is reflected in the premium of the option if the strike price of a put option is 20 and the underlying is stock is currently trading at 19 there is 1 of intrinsic value in the option but the put option may trade for 1 35 the extra 0 35 is time value since the underlying stock price could change before the option expires different put options on the same underlying asset may be combined to form put spreads there are several factors to keep in mind when it comes to selling put options it s important to understand an option contract s value and profitability when considering a trade or else you risk the stock falling past the point of profitability the payoff of a put option at expiration is depicted in the image below 