What are Put Options (🎙️Listen on Racket)
In my last Racket I said that insurance is a bet the value of something, like your health, will go down, and I compared it to short selling which is a bet that the value of a stock will go down.
Listener Theta wrote in to disagree, saying that Put options are actually a better comparison to insurance than short selling. I tend to agree, so let's talk about put options.
When you're short selling, you're selling something you don't own. So you first have to borrow it, sell it, and then later buy it back to reimburse the lender.
A put option, just like a short, is also a strategy you can take when you think the price of a stock will go down in the future.
In this case you're not buying, borrowing, or selling a stock. at least not yet. You're just buying the right to sell the stock at an agreed, fixed price. for example today's price. The counterparty to this contract is therefore agreeing to buy the stock from you at that agreed price.
It's called a put because it gives you the right to PUT the stock for sale.
The idea is that when the price of the stock goes down you buy the stock on the open market, and then use your put option to immediately sell it at the contractually agreed higher price.
In contrast to short selling, you're not forced to take any action. In a short sell you must at some point buy the stock again. Whereas with an option it's just that, optional.
This is the reason Put options are a better comparison to insurance. You carry the option to "win" the decrease in value, but you won't lose money if the value goes up, at least not more than the fees you pay.