Definition of Put Option

Put Option is a derivative instrument that gives the holder a right to sell a security at a certain price at the expiration date. An option is a right, not an obligation to buy or sell a security at a future date at a given price.

A person who wants to secure a higher selling price when the prices are falling may decide to buy a put option. The writer of the put option charges a minor fee for which he commits to buy the security (e.g. IBM Share) at the strike price ($5.00) from the holder of the put option. If the market value of IBM's share falls below $5.00 the holder will exercise the option and the writer has to buy the share from the holder for $5.00. But if the market value of IBM's share increases to $5.50, the holder will not exercise the option as it is a right, not an obligation. The holder will sell IBM's share in the open market at $5.50.