Put options are the opposite of calls. Using puts, it is possible to invest and benefit from declines in the stock market or in individual stocks - without ever owning them. When you buy a put you are forecasting that the stock’s price will fall in value before the put’s expiration date.
Video Analysis: How to Trade a Put Option
Buying puts is often compared to shorting a stock. But, although they are both bearish positions, buying puts is quite different. In fact, buying a put can be better than shorting the stock itself because your risk is limited to the amount you paid for the put option.
If the market falls, both trades would be profitable but if the market rises, your risk in a short stock trade is theoretically unlimited.
The process of buying a put is relatively simple. Typically, you want to find a stock in a firm downtrend that you feel is likely to remain in a downtrend. Once you have selected your “bearish” stock, buying a put works the same way as buying a call.
In the chart below, you can see that the iShares Russell 2000 ETF (IWM) had been stuck in a dramatic downtrend and by mid-Feb was bouncing back down from a resistance level at $73 after a brief rise in January. This was a great candidate to for a put trade.
Running through a very similar trade entry process that I discussed in the calls lesson, we would start with buying a put with a strike price closest to the current stock price. Since the stock was currently priced at $70.18 the 70 strike with about 30 days left before expiration looks like an ideal candidate.
The 70 put would have cost $2.60 a share or $260 per contract on February 14. In the chart below, you can see the stock subsequently dropped significantly, to $65 by March 10. Assuming that you exited your trade by at that time by selling the put at market value, for $3.70 a share or $370 per contract, you would have harvested a nice profit of $110 and a return of 42% in less than 30 days.
1. Purchased 70 put on Feb 14: $260 2. Sold 70 put on Mar 10: $370 3. Profits: $110 4. ROI: 42% (110 / 260 = .42)
As with call options, you have the ability to buy and sell put options before expiration. A put option will rise in value as the stock drops and will decline in value as the stock rises. This gives you the flexibility as an option investor to take advantage of a volatile stock market.
In the video below we will review how time value affects the growth of a put trade. We will also discuss the impact of increasing the time before expiration on the price of a put. There will be times, as a trader, that you will want more than 30 days before an option expires but this will change the price of the option and is something that you will want to plan for.
Rajiv Malhotra
- A very good explanation about options
|2009-02-05 02:06:15
Thanks for posting the content. As a new peorson in market this was very helpful in understanding the various options. Though I could not get one answers after all reading and watching videos.
Why someone need to look at different strike price for the same expiration date , if he/she does not want to exercise the option ( which I think would be the most common case for any individual as explained in this tutorial)
Benji
- Discovery
|2009-10-04 06:03:29
This is actually contrary to how I thought it worked, interesting.
planecents
- put expiration
|2009-10-08 15:07:33
What happens to the stock at expiration if you hold the put? In the case of WFMI at strike of 26 and the stock moves lower to say 24?
John Jagerson
- Put expiration
|2009-10-09 02:49:44
if you own the put at expiration and it is "in the money" as you have suggested then your broker will exercise that option and "put" the stock to the seller. You would profit in this situation because you are putting the stock to someone else for $26 while the stock is only worth $24.
However, most traders will have exited the position and just taken their profits off the table before expiration.
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