Put Option

Put option is a derivative instrument which gives the buyer of the option (holder) the right but not the obligation to sell the underlying asset at a fixed price (exercise or strike price) after a specified period of time (on maturity for European and anytime before maturity for American option). The seller of the put option (put writer) has a contingent obligation to purchase the underlying asset if the put holder wishes to exercise the option. As the option gives the buyer a choice to exercise the option or not, the seller charges a fixed upfront fee from the buyer (known as premium).

 

Example: ABC is an American company with a project in Australia. It has some account receivables in Australian Dollar (AUD) which will be realized after 3 months. The USD value of this receivable will reduce if AUD depreciates. It can purchase put options on AUD with a 3 months maturity to sell the AUD at a fixed exchange rate after three months.