A put option is the right, but not the obligation, to sell stock (or another security) underlying the option, for a specified price, on or before a specified date.

Most people understand put options in the context of an insurance policy.

For example, an insurance policy on a house will pay the homeowner for any damages done to a house. Thus if a house is valued at $250,000, and the house burns down to the ground (and is fully destroyed), the insurance company will pay to the homeowner $250,000 in proceeds.

To obtain an insurance policy, one would pay a price to own the insurance policy (let's say $1,000), and then the insurance policy would be in effect for a specific period of time (for example 1 year). At the end of the 1 year period, you would either have to re-new your insurance policy by making a new payment, or the insurance policy would expire. A put option works exactly the same way.

As stated above, a put option in the securities markets, is the right, but not the obligation, to sell stock (or another security) underlying the option, for a specified price, on or before a specified date.

For example, a put option on stock presently is the IBM September 80 put option (symbol IBMUP). This put option would give you the right, but not the obligation, to sell (IBM | Quote | Chart | News | PowerRating) stock for $80 a share until September options expiration (the third Friday of September, 2006).

IBM stock is currently trading at $79.30 a share. If the stock moved in value under $80 a share, you would use the put option to sell the IBM stock for $80 a share, and then you could buy the stock back for a profit in the open market for less than $80 a share.

Conversely if IBM stock was to move above $80 a share at September options expiration, you would let your option expire worthless as there would be no reason to sell IBM stock for $80 a share when you could go into the open market and sell IBM stock for more than $80 a share.

Like an insurance policy, a put option is designed to protect your securities from losses, especially unexpected or unpredictable losses.

Thus, if you owned the IBM 80 put option stated above, and during the option period it was announced that IBM's revenues were false and based upon fraud, and the stock dropped to $40 a share, you could then use your put option to go into the open market and sell the stock for $80 a share. This would protect you against all losses that would have been incurred if you owned IBM stock and it dropped the 39 points stated above.