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 Put Option?83 Views
finance a la shmoop what is a put option? hot potato hot potato
ow ow! yeah remember that game well nobody wanted the potato, poor thing. the
players wanted to put it in someone else's hands. well put options kind [glue put around a flaming potato]
of work the same way. a put option is the right or option or choice to sell a
stock or a bond at a given price to someone by a certain end date.
all right example time. you bought netflix stock at the IPO a zillion years
ago at $1 a share. that's you know splits adjusted. all right now it's a hundred
bucks a share. if you sell it you pay taxes on a gain of 99 dollars a share. in
California that would be a tax of something like almost 40 bucks. well the
stock was a hundred but you keep only something like 60. feels totally unfair.
right so you really don't want to sell your stock but you're nervous about the [graph shown]
next few months that Netflix will crater for a while and go down ten
maybe twenty dollars. longer term though you think it'll hit 300. so this is the
perfect setup to maybe look at buying some put options on Netflix. if the stock
goes down your put options go up. with Netflix volatile but at a hundred bucks
a share ,you look up the price of an $80 strike price put option expiring in
December, and you know that's mid-september now .for five bucks a share
you can protect your stock for the next few months .think about it like temporary [stocks placed in vault]
term life insurance. you pay the five dollars a share in the stock goes down
to 82 by mid December, worst of all worlds. well not only did you lose the $5
a share but your stock has lost $18 in value. but had Netflix really cratered
and gone to say $60 a share well you would have exercised your put and sold
your shares at 80 bucks. well those put options you paid $5 for
would be been worth 15 bucks a share. in buying that put option you've [equation shown]
guaranteed that your loss will be no more than a $75 value for your Netflix
position at least for that time period and ignoring taxes. well remember that
options expire after December whatever like the third Friday of the month it's
usually when options expire, you then have no protection and your shares float
along naked. naked? really who knew accounting could get so [paper put option goes "skinny dipping".]
raunchy. yeah well that's naked put options.
that's what they really are people.
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