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text courtesy Wikipedia
A put or put option is a contract between two parties to exchange an asset (the underlying), at a specified price (the strike), by a predetermined date (the expiry or maturity). One party, the buyer of the put, has the right, but not an obligation, to sell the asset at the strike price by the future date, while the other party, the seller of the put, has the obligation to buy the asset at the strike price if the buyer exercises the option.
If the strike is K and maturity time is T, if the buyer exercises the put at a time t, the buyer can expect to receive a payout of K-S(t), if the price of the underlying S(t) at that time is less than K. The exercise t must occur by time T; precisely what exact times are allowed is specified by the type of put option. An American option can be exercised at any time before or equal to T; a European option can be exercised only at time T; a Bermudan option can be exercised only on specific dates listed in the terms of the contract. If the option is not exercised by maturity, it expires worthless. (Note that the buyer will not exercise the option at an allowable date if the price of the underlying is greater than K.)
The most obvious use of a put is as a type of insurance. In the protective put strategy, the investor buys enough puts to cover their holdings of the underlying so that if a drastic downward movement of the underlying's price occurs, they have the option to sell the holdings at the strike price. Another use is for speculation: an investor can take a short position in the underlying without trading in it directly.
Puts may also be combined with other derivatives as part of more complex investment strategies, and in particular, may be useful for hedging. Note that by put-call parity, a European put can be replaced by buying the appropriate call option and selling an appropriate forward contract.
The terms for exercising the option's right to sell it differ depending on option style. A European put option allows the holder to exercise the put option for a short period of time right before expiration, while an American put option allows exercise at any time before expiration.
The most widely-traded put options are on equities, but they are traded on many other instruments such as interest rates (see interest rate floor) or commodities.
The put buyer either believes that the underlying asset's price will fall by the exercise date or hopes to protect a long position in it. The advantage of buying a put over short selling the asset is that the option owner's risk of loss is limited to the premium paid for it, whereas the asset short seller's risk of loss is unlimited (its price can rise greatly, in fact, in theory it can rise infinitely, and such a rise is the short seller's loss). The put buyer's prospect (risk) of gain is limited to the option's strike price less the underlying's spot price and the premium/fee paid for it.
The put writer believes that the underlying security's price will rise, not fall. The writer sells the put to collect the premium. The put writer's total potential loss is limited to the put's strike price less the spot and premium already received. Puts can be used also to limit the writer's portfolio risk and may be part of an option spread.
The put buyer is short on the underlying asset of the put, but long on the put option itself. That is, the buyer wants the value of the put option to increase by a decline in the price of the underlying asset below the strike price. The writer (seller) of a put is long on the underlying asset and short on the put option itself. That is, the seller wants the option to become worthless by an increase in the price of the underlying asset above the strike price. Generally, a put option that is purchased is referred to as a long put and a put option that is sold is referred to as a short put.
