Put Option Buying 
The purchase of a put option provides leverage in the case of a downward move by 
the underlying stock. In this manner, it is an alternative to the short sale of stock, 
much as the purchase of a call option is a leveraged alternative to the purchase of 
stock. 
PUT BUYING VERSUS SHORT SALE 
In the simplest case, when an investor expects a stock to decline in price, he may 
either short the underlying stock or buy a put option on the stock. Suppose that XYZ 
is at 50 and that an XYZ July 50 put option is trading at 5. If the underlying stock 
declines substantially, the buyer of the put could make profits considerably in excess 
of his initial investment. However, if the underlying stock rises in price, the put buyer 
has limited risk; he can lose only the amount of money that he originally paid for the 
put option. In this example, the most that the put buyer could lose would be 5 points, 
which is equal to his entire initial investment. Table 16-1 and Figure 16-1 depict the 
results, at expiration, of this simple purchase of the put option. 
The put buyer has limited profit potential, since a stock can never drop in price 
below zero dollars per share. However, his potential profits can be huge, percent­
agewise. His loss, which normally would occur if the stock rises in price, is limited to 
the amount of his initial investment. The simplest use of a put purchase is for specu­
lative purposes when expecting a price decline in the underlying stock. 
These results for the profit or loss of the put option purchases can be compared 
to a similar short sale of XYZ at 50 in order to observe the benefits of leverage and 
limited risk that the put option buyer achieves. In order to sell short 100 XYZ at 50, 
assume that the trader would have to use $2,500 in margin. Several points can be ver-
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