If you’re interested in trading options, you need to understand the difference between the two major types—calls and puts.

First, let’s review how options work. An option is a contract. It gives you the right—but not the obligation—to buy or sell an asset at a specific price before a certain date.

As I mentioned, there are two types of options. One is the put option. It gives you the right to sell an asset at a certain price by a certain date.

That may seem complicated, so let’s look at an example.

Let’s say you own 100 shares of a company called Lemon Car Dealers, which you bought at $100 a share, and is still trading at $100 a share.

For some reason, you think the stock might decline in value, and you want to protect yourself. After all, if the company goes out of business, you’d be out 100 shares at $100 each, which is a total of $10,000.

So, you buy an options contract for $1,000. This particular contract lets you sell 100 shares of Lemon Car Dealers for $80 a share.

As you suspected, Lemon Car Dealers goes out of business. But guess what? You have a contract! You can sell the shares for $80 each. You get $8,000 from the sale, so you only have lost $2,000 of your original investment, plus the $1,000 the options contract cost you.

So, to sum up, put options are similar to “shorting” stock. You would buy a put option on a stock if you think the stock will decrease in value before the option expires.

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