A put option grants the buyer (long put) the right — but not the obligation — to sell 100 shares of an underlying security at the strike price on or before expiration. The put buyer pays a premium to the put seller (short put). If exercised, the seller must purchase the shares at the strike price.
A put is in the money (ITM) when the stock price is below the strike price; out of the money (OTM) when the stock is above the strike. This is the mirror image of call options. Long puts are used to hedge a long stock position (protective put) or to speculate on a price decline. Short puts (naked puts) generate premium income but expose the writer to downside risk if the stock falls substantially.
Protective put = long stock + long put — this combination functions like insurance. The maximum loss is limited to (Purchase Price − Strike Price + Premium Paid). The maximum gain is theoretically unlimited minus the premium paid. Break-even for a long put: Strike − Premium.
For the short put: maximum gain = premium received; maximum loss = Strike − Premium (if stock goes to zero). Short puts require margin and are only suitable for investors who are willing and able to purchase the stock at the strike price.
> Exam tip: On the Series 7, know all four basic option positions cold. Put break-even = strike price − premium. Know that buying a put is bearish; selling a put is moderately bullish. The protective put (long stock + long put) establishes a floor on losses — a key concept for the Series 65/66 and CFP regarding portfolio hedging strategies. Remember: puts profit when prices fall.