Because there are hundreds of different puts with different parameters trading against each stock with options trading, you can find put contracts which cost just a few dollars up to puts costing thousands of dollars. The important consideration is determining whether buying the put can make you money. It is probably better to spend $500 on a put and make a $500 profit than to spend $50 and lose the whole $50.
Put Options Function
A put option gives the option buyer the right to sell the underlying stock at a specific price. Puts are purchased to profit from a falling share price. Option contracts are defined by the underlying stock, the stock price at which the option can be exercised -- called the strike price -- and an expiration date. A put option has value at expiration if the stock price is below the strike price. If not, the option expires without any value. A purchase put option can be later sold to realize a profit. It isn't necessary to exercise the contract.
Put Option Pricing
A series of put options with different expiration dates and strike prices will trade against a single stock. Put options with higher strike prices will have higher prices to purchase. Puts for more distant expiration dates are more expensive because there is more time for the stock to move and make the put purchase profitable. One put option is for 100 shares, so the cost of one contract is 100 times the quoted price. For example, a stock has a current stock price of $30. A put with a $30 strike price is quoted at $2.50. It would cost $250 plus commission to buy the put. This put would have intrinsic value -- money you could get if the option was exercised -- if the stock declines below $30.
Put Option Examples
Consider two put option choices on the $30 stock. The put with the $30 strike price is quoted at $2.50. A put with a $25 strike price is priced at $0.50 for a cost of $50. The value of a put option increases by $1.00 -- $100 per contract -- for each dollar the stock price drops below a put option strike price. The time premium paid for the option -- in this case, the $2.50 and $0.50 -- will erode as the expiration date approaches. If the underlying stock drops to $25 by the expiration date, the more expensive put will be worth at least $500 for a $250 profit, and the cheaper put will expire without value -- a 100 percent loss.
Option Probability Calculators
Your online brokerage account most likely provides an option probability calculator. This calculator will take the option price, strike price, underlying stock price and expected volatility of the stock to calculate the probability that an options trade will be profitable. Use the calculator to compare the probabilities of success between low-priced and more expensive options. The options with the higher strike prices and higher costs also have a higher probability of success.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.