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Definition: Put on a Put
A put on a put is a compound option which has a put option as the underlying for another put option. On the expiration date the buyer of a put on a put has the right but not the obligation to sell the underlying put option - also known as the vanilla option. Its value changes in commensurate to the price of the underlying put, i.e. an increase is witnessed as the price of the underlying put increases, and a decrease as the asset price decreases.
This option is used when it is desired to have leverage, and given that the broker is moderately bullish on the underlying asset. Also known as a split-fee option.
1. A put on a put is characterized by two strike prices and two expiration
a. One for the initial compound out option
b. Another for the underlying put
2. Compound options like put on put have European-style exercise, which means that they can only be exercised on the expiration date.
3. Since one of the determining factor in the price of the put on put is the price of the underlying put, the cost of a put on a put option will be lower than the cost of a put on the underlying put. Hence it provides immense leverage to the options trader.