A put represents the option (meaning the right, but not the obligation) to sell an underlying asset (like a stock) at a pre-set price at a pre-set point in the future. Essentially, you use it as a way to bet that the price of a stock (or whatever asset) will decline.
AAPL is trading at $200. You buy a put with a $190 strike price. Shares fall to $170 by the time the put expires. You can exercise the put, forcing someone to buy the stock from you at $190 (shares you can just grab in the open market at $170, making you a profit of $20 each, minus the expenses related to purchasing the put). The nice thing about the put is that there's no real penalty for the stock going up. You lose the amount you paid for the option, but otherwise, no harm, no foul. If AAPL's stock rises to $225 a share, and you're holding a put at $190, you just let the put expire. You don't have to sell the shares at $190. You have the option.
This scenario is different than a short sale, another way of betting that a stock will go down. That process involves borrowing stock, selling it on the open market, and then hoping it declines in value. If it does, you buy the shares back at the lower price, return them to the person you borrowed them from, and pocket the difference. However, if the stock rises, you can lose tons of money. Theoretically, an infinite amount (although...you're liable to cover your short at some point, rather than let the stock actually climb to infinity).
A synthetic put is essentially a short, but with a hedge involved. You short the stock, but simultaneously buy a call for the same stock, with a strike at the same price where you shorted the shares. A call represents the opposite of a put. It gives the holder the right, but not the obligation, to buy shares at a pre-set price at a pre-set time. Having the call protects you from the downside of the short sale. If the AAPL stock rises to $225, no fear. You purchased a call. You just exercise the call at $200 (the point at which you shorted the stock).
It's essentially a do-over. You use the call to purchase the stock at the original price, and return that to the person you borrowed it from. The deal has the same outcome as a put. Which is why it's known as a "synthetic put." It provides the same action as holding a put...without actually using a put to do it.
Related or Semi-related Video
Finance: What is a Derivative?23 Views
finance a la shmoop what is a derivative? well it's derived it's a something taken
from something else like a derivative of hot weather is thirst a derivative of [Girl takes sip of glass of water on a beach]
hunger is well you know crankiness that's diva thing you get there...
derivative of a 1/32 quarterback rating in the NFL is like serious wealth yeah
yeah discount double shmoop yeah look for it be on there with aaron
and a derivative of a stock or bond or other security is a something which
derives its value based on the performance of that underlying security
there are basically two flavors of derivative put options ie the right to [Ice cream flavors appear]
sell a security at a given price over a given time period and a call option, ie
right to buy a security at a given price over a given time period
well the price of that option is derived from the price of the security and a few
other factors like strike prices and duration and all that stuff
colonel electric the downgraded new version of General Electric is trading [Colonel Electric appears in a suit]
for 25 bucks a share a derivative of its share price is sold in the form of a
call option with a $30 strike price expiring about 90 days from now on the
third Friday of the end of that month well investors pay a price albeit
probably a small one for the right to then pay 30 bucks a share for colonel [Call option appears for colonel electric]
electric at any time in the next 90 ish days until that option expires making the bet
that the stock will go well above 30 bucks a share in that time period that
call option is thus a derivative of the colonel electric primary stock price got
it if you really want to get personal well here's the ultimate form of
derivative [Baby laying down]
Up Next
What is a put option? A put option is a type of contract that lets the investor sell shares of a stock at a certain price and within a window of ti...
What is a call option? A call option is a type of contract that lets the investor buy shares of a stock at a certain price and within a window of t...