The Put Option
A put is the opposite of a call. It is a contract granting the right to sell 100 shares of stock at a fixed price per share and by a specified expiration date in the future. As a put buyer, you acquire the right to sell 100 shares of stock; and as a put seller, you grant that right to the buyer.
[caption id="attachment_12414" align="alignleft" width="370"] The put option[/caption]
Buying and Selling PutsAs a buyer of a put, you hope the underlying stock's value will fall.
- The market value of the stock rises. In this case, the put's value falls in response. Thus, you may sell the put for a price below the price you paid and take a loss; or you may hold on to the put, hoping that the stock's market value will fall before the expiration date.
ExampleTurning It Upside Down: You bought a put two months ago, paying a premium of 2 ($200). You expected the stock's market price to fall, in which case the value of the put would have risen. Instead, the stock's market value rose, so the put's value fell. It is now worth only 0.25, or $25. You have a choice: Sell the put and take a $175 loss, or hold on to the put, hoping the stock will fall before the expiration date. If you hold the put beyond expiration, it will be worthless and your loss will be the full $200.
- This example demonstrates the need to assess risks. For example, with the put currently worth only $25 -- nearly nothing -- there is very little value remaining, so you might consider it too late to cut your losses in this case. Considering that there is only $25 at stake, it might be worth the long shot of holding the put until expiration. If the stock's price does fall between now and then, you stand the chance of recovering your investment and, perhaps, even earning a profit.
Smart Investor TipOption traders constantly calculate risk and reward, and often make decisions based not upon how they hoped prices would change, but upon how an unexpected change has affected their position.
- The market value of the stock does not change. If the stock does not move significantly enough to alter the value of the put, then the put's value will still fall. The put, like the call, is a wasting asset; so the more time that passes and the closer the expiration date becomes, the less value will remain in the put. In this situation, you may sell the put and accept a loss, or hold on to it, hoping that the stock's market price will fall before the put's expiration.
ExampleChoosing between Bad and Worse: You bought a LEAPS put several months ago and paid a premium of 7 ($700). You had expected the stock's market value to fall, in which case the put's value would have risen. Expiration comes up later this month. Unfortunately, the stock's market value is about the same as it was when you bought the LEAPS put, but that put is now worth only $100. Your choices: Sell the put for $100 and accept the $600 loss, or hold on to the put on the chance that the stock's value will fall before expiration.
- The choice comes down to a matter of timing and an awareness of how much price change is required to produce a breakeven point or a profit. In the preceding example, the stock would have to fall at least seven points below the put's striking price just to create a breakeven outcome (before trading costs). In this case, even utilizing a longer