Buying put options is one of the most straightforward ways to profit when you believe a stock will decline. Unlike shorting stock, which has unlimited risk, buying puts gives you defined risk with significant profit potential. Whether you want to speculate on downward moves or protect your portfolio, this guide will teach you everything about buying put options.
What is a Put Option?
A put option is a contract that gives you the right, but not the obligation, to sell 100 shares of a stock at a specific price (the strike price) before a certain date (the expiration date). When you buy a put, you pay a premium for this right and profit when the stock falls below your strike price.
Key concept: Buying a put option is a bearish bet. You want the stock price to fall. The lower it goes below your strike price, the more money you make.
Why Do Traders Buy Put Options?
There are two main reasons traders buy puts:
1. Speculation on Downward Moves
If you believe a stock is overvalued or about to decline, buying puts lets you profit from that move:
- Lower capital requirement than shorting stock
- No borrowing fees or margin requirements
- Risk limited to the premium paid
- Leverage amplifies your returns
2. Portfolio Protection (Hedging)
Puts can protect your existing stock positions:
- Protective puts: Buy puts on stocks you own to limit downside
- Portfolio insurance: Buy puts on index ETFs like SPY to hedge market risk
- Earnings protection: Hedge before potentially volatile announcements
How to Select the Right Put Option
Choosing the right put involves several decisions:
Strike Price Selection
- In-the-money (ITM): Strike above current stock price. Higher cost, higher probability of profit
- At-the-money (ATM): Strike near current stock price. Balanced approach
- Out-of-the-money (OTM): Strike below current stock price. Cheaper, but needs bigger move to profit
Expiration Date Considerations
- Short-term (1-2 weeks): Cheap but rapid time decay. Best for quick moves
- Medium-term (30-60 days): Good balance of cost and time
- Long-term (90+ days): More time for thesis to play out, but higher premium
Example: Buying a Put Option
Stock ABC is trading at $100. You believe it will drop to $80 after earnings.
- You buy 1 put option with a $95 strike price
- Expiration: 45 days out
- Premium paid: $4.00 per share ($400 total)
- Breakeven price: $91 ($95 strike - $4 premium)
If ABC falls to $75 at expiration, your put is worth $20. After subtracting your $4 cost, your profit is $16 per share, or $1,600 total. That is a 400% return.
Calculating Put Option Profits
Understanding your potential outcomes before trading is essential:
- Maximum loss: Premium paid (occurs if stock stays above strike at expiration)
- Breakeven point: Strike price minus premium paid
- Profit formula: (Strike price - Stock price - Premium paid) x 100
- Maximum profit: Strike price minus premium (if stock goes to zero)
Profit Scenarios
You buy a $50 strike put for $3.00 premium ($300 total).
- Stock at $55 at expiration: Loss = $300 (full premium)
- Stock at $47 at expiration: Breakeven (no profit or loss)
- Stock at $40 at expiration: Profit = ($50 - $40 - $3) x 100 = $700
- Stock at $30 at expiration: Profit = ($50 - $30 - $3) x 100 = $1,700
When to Buy Put Options
Puts work best under certain conditions:
- Bearish market outlook: You expect the overall market to decline
- Company-specific concerns: Poor earnings, management issues, or sector problems
- Technical breakdowns: Stock breaking below key support levels
- Overextended rallies: Stocks that have risen too far, too fast
- Hedging existing positions: Protecting profits in stocks you own
Using Puts as Portfolio Insurance
One of the most important uses of puts is protecting your investments:
Protective Put Strategy
If you own 100 shares of a stock you want to protect:
- Buy one put option for every 100 shares owned
- Choose a strike price at your maximum acceptable loss level
- Select an expiration that covers your risk period
Protective Put Example
You own 100 shares of XYZ at $100 (total value: $10,000).
- You buy a $90 put for $2.00 ($200 cost)
- Your maximum loss is now limited to $1,200 ($1,000 stock loss + $200 put cost)
- Without the put, you could lose your entire $10,000 investment
Risk Management for Put Buyers
Follow these guidelines to protect your capital:
- Size positions appropriately: Risk only 1-3% of your account per trade
- Set profit targets: Take gains at 50-100% profit
- Cut losses: Exit if the position loses 50% of value
- Avoid expiration week: Time decay accelerates dramatically
- Watch implied volatility: High IV means expensive premiums
Common Mistakes to Avoid
New put buyers often make these errors:
- Fighting the trend: Buying puts in a strong uptrend is usually a losing battle
- Buying too far OTM: Deep out-of-the-money puts are cheap but rarely profitable
- Ignoring time decay: Puts lose value every day, even if the stock moves your way
- Holding through earnings: IV crush after earnings can destroy put value
- No exit strategy: Always know when you will sell before you buy
Puts vs Shorting Stock
Understand the differences between these bearish strategies:
- Risk: Puts have limited risk; short selling has unlimited risk
- Capital: Puts require less capital than shorting
- Time limit: Puts expire; short positions can be held indefinitely
- Dividends: Short sellers pay dividends; put buyers do not
- Borrowing: No need to borrow shares when buying puts
Track Your Put Option Trades
Pro Trader Dashboard automatically imports and tracks all your options trades. See your performance on puts versus calls, track your hedging effectiveness, and improve your trading decisions.
Summary
Buying put options is an essential skill for options traders. Whether you are speculating on declining prices or protecting your portfolio, puts provide a defined-risk way to benefit from downward moves. Choose your strikes and expirations carefully, manage your position sizes, and always have an exit plan. With proper risk management, buying puts can be a valuable addition to your trading arsenal.
Continue learning with our guides on understanding put options or explore selling put options for a different approach to bearish trading.