I wish I knew what a put option was, but I’m too embarrassed to ask
A put option gives the holder the right (but not the obligation) to sell an asset, such as a share, for an agreed price, on or before a certain date. When you buy a put option, you pay a fee
(known as a premium) to the seller of the option (also known as the writer of the option). If you exercise the option, the seller must buy the underlying asset from you at the agreed price. Otherwise the option expires worthless and the seller has no further liabilities.
Let’s assume that Acme Widgets is trading at 100p per share and a put option to sell at 90p costs 5p. You buy a block of 1,000 options at a cost of £50
(5p × 1,000). If the shares fall to 70p, you would make a profit of £150 ((90p − 70p − 5p) × 1,000). However, if the shares go up – to 120p, say – you let the option expire. In that case, you lose your premium of £50 but nothing more.
You can use put options to bet on the price of a share or other asset falling, or to protect against the risk of that. You might buy a put option on the FTSE 100 because you think the market could crash. If shares then fall sharply, your put options should make a profit, helping to offset the fall in the value of your investments.
The price of an option is determined by a number of factors, including the volatility of the price of the underlying asset (options on more volatile assets will be more expensive). So option prices tend to rise during market turmoil. The length of time that an option still has to run before it expires is also important, with options that expire further into the future being more expensive.
Options may be physically settled (the seller must deliver the asset to the buyer in exchange for payment), or cash settled (the seller makes a payment equal to the difference between the strike price and the current price of the asset). Options on shares are usually physically settled. Options based on something that is hard to deliver – eg, a stock index such as the FTSE 100 – will be cash settled.