Put option

Options give you the right to buy or sell something (often shares, but they can be used in connection with other financial assets) for an agreed price on or before a certain date. A put option gives someone the right to sell a share.

In order to have the option to buy or sell something, you have to pay a fee known as a premium to the seller of the option (who is known as the option writer). You might buy a put option if you thought that a share was likely to fall in price and you wanted to profit from that happening.

Another way to use put options is to hedge your portfolio against a drop in the market. For example, fund managers often buy put options on a stockmarket index to protect their portfolio – so that if the stockmarket falls, the profits on the option will offset the losses on the shares in the portfolio.

In the UK, options contracts are sold in blocks of 1,000 shares. Say XYZ plc is trading at 100p per share and a put option, giving the right to sell at 90p, costs a premium of 5p. The cost of the option is £50 (5p x 1,000). If the shares fall to 70p, you would make a profit of £150 ((90p-70p-5p) x 1,000).

If the shares go up, you let the option expire, and you lose your entire premium paid of £50.

Merryn

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