Back to Basics: Three Ways To Profit With Put Options

The two primary types of options strategies are call options and put options.

In keeping with our back to basics Fridays, I am going to show you a few different ways you can profit using put options.




The Buying a Basic Put Option For Profits

As you have learned, a put option gives an investor the right, but not the obligation, to sell its underlying stock a specific price. The contract is almost always 100 shares per contract. The expiration date is the day in which the option expires.

Buying Put options involves just that, buying only the Put option.

When you buy only the Put option it completely changes the dynamics of the trade. You want the stock price to fall because that is how you make your profit.

In “most” cases you never intend on exercising your rights to sell the stock. You just want to benefit from the movement of the stock without having to own the stock, and you can do this with Put options.

A Put option locks in the selling price of a stock.

So if you buy an option with a strike price of $70 this will allow you to sell the stock for $70 anytime between the day you buy the option and when it expires.

So if the stock falls to $60 your Put option will go up in value. Why, because you hold a contract that gives you the right to sell something for more than its market value.

Yes this seems unfair and logically this doesn’t make sense, but this is just the nature of the terms of the option contract.

Simply Writing Puts for Income

Buying a put is like shorting a stock, or profiting from the fall in its price.  Investors can also short a short, and write a put option.  We have discussed the two sides of an option contract in the past, the buyer and the seller.

In this case, when you write a put option you receive income in the form of premium from selling the contract.  When you sell a put, you are hoping the stock stays above the strike price or you will be ‘put’ the stock.  This will happen when the stock price falls below the strike.

When you write put options, the investor is betting the stock price will remain above the exercise price during the term of the option.  If this does happen, the investor gets to keep the entire premium.  This is a great strategy for a bull market.

Mixing a Put with Another Option

Some more intrepid investors want something more advanced and will combine a put with a call.  This is called a straddle and consists of buying a put as well as going long a call.  This is a scenario where the investor thinks there is a big move in either direction, up or down.

Let’s assume a stock trades at $15.  The straddle can be as simple as buying the put and the call at a strike price of $15.

Two long options are purchased using the same expiration, and a profit is reached if the stock moves up or down beyond the cost of the premium you paid to purchase the options.

Let’s say Stock X is trading at about $15 per share.  A call option will trade around $.25 and a put will sell for $.20 for a total cost of $.45 for a single contract.  In this case, the stock would have to move beyond $15.45 for the call option to be profitable or $14.55 for the put option to be profitable.



Back to Basics 

In keeping with my back to basics Friday, I hope this simple explanation of how to profit with put options was helpful.

 

— The Option Specialist

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About the Author: The Option Specialist