Put Option Buying - Put Strategies
What are Put Options?
A Put is a contract on a particular stock, index or other
security that allows the investor to sell the underlying stock
at a set price (strike price).
The holder of his option has paid a premium (cost of the
contract) to buy it. Put options are profitable when the market
is in decline. If the investor has a put on a stock that has now
fallen enough to cover the cost of the premium, the person would
be profitable.
Ways to Profit with Put Options
Trading them:
If the Put is profitable, the investor can sell or trade the
contract back to the market. The profit on the contract is shown
by the premium increase on the option. As the market declines,
the premium increases. This premium increase allows the investor
to sell the contract. He is not "exercising the option". He is
trading it out. This is how most options are done vs. exercising.
Exercising them:
When an investor exercises a Put Option, he or she is selling a
stock they already own. The right of a put holder is the right
to sell the stock at the strike price, regardless of the actual
price in the market. If you owned a Put with a strike price of
50, and the market has declined to 40, you could purchase the
actual the stock in the market at 40 and then exercise the put
at 50. You would make 10 points on that stock, minus the premium
paid.
The break-even for investors who own put options (disregarding
commissions) is the strike price minus the premium paid. In the
above example, if the investor paid $300 for the option - his
break-even would be 47. Since the market in our example went
down to 40, the actual profit for that person would be $700.
Writing a Put Option
When you sell or short a put option, you are "writing" the
contract. The writer is someone who is bullish on the market.
The seller collects the premium (as opposed to the buyer who
pays the premium) and is hoping the option expires worthless.
The premium is the writer's maximum gain. So, obviously if the
premium is all that he can make - having the option expire is
the best case scenario.
Put option writing does carry risk. If the option is exercised
(by the holder/buyer), the writer must purchase the stock from
the holder at the strike price. In the example above, the writer
would have had to buy the stock at $50 (the current price),
while the market was at $40. He would be stuck with a stock 10
points above the market. His loss would be lessened by the
premium received. The writer can buy back the put before it is
exercised, but if the put has gained value, the purchase price
would be higher than the premium he originally got - so, it
would be a loss either way. The option is expiring is the best
bet.
Covered Put Option Writing Strategies
Since the seller or writer of puts must purchase the underlying
stock at the strike price, he must have the cash to do that.
Selling stock short and using the proceeds to cover an exercised
option can be a profitable strategy. Also, the premium received
for selling the put option can assist a short position to get
greater profit.
As with any option, time is the biggest factor. Put options
expire monthly. All options carry large risks, but can present
large profits. Educate yourself further and talk to your broker.
Learn More: Put Options