A put option gives its buyer the right, but not the obligation, to sell an underlying asset at a specified strike price before expiration. The buyer pays a premium, like purchasing an API key that can activate sell() under defined conditions; if those conditions never help, the option can expire and the premium is lost. section 1.2.7
Protecting ACME stock
Pedro owns ACME shares bought at $100 and buys a put with a $95 strike before an earnings call. If the stock stays above $95, the premium functions like unused insurance. If it falls below $95, he can sell at $95, limiting the downside. The protection has a cost and does not eliminate every investment risk. section 7.4.1
The main trade-offs are:
- Buying a put limits the buyer’s loss to the premium paid when the option is not exercised. section 1.2.7
- Selling a put produces premium income but creates an obligation to buy at the strike price if exercised; a severe price collapse can produce a disastrous outcome. section 1.2.7
