Best of the Week
Most Popular
1. Investing in a Bubble Mania Stock Market Trending Towards Financial Crisis 2.0 CRASH! - 9th Sep 21
2.Tech Stocks Bubble Valuations 2000 vs 2021 - 25th Sep 21
3.Stock Market FOMO Going into Crash Season - 8th Oct 21
4.Stock Market FOMO Hits September Brick Wall - Evergrande China's Lehman's Moment - 22nd Sep 21
5.Crypto Bubble BURSTS! BTC, ETH, XRP CRASH! NiceHash Seizes Funds on Account Halting ALL Withdrawals! - 19th May 21
6.How to Protect Your Self From a Stock Market CRASH / Bear Market? - 14th Oct 21
7.AI Stocks Portfolio Buying and Selling Levels Going Into Market Correction - 11th Oct 21
8.Why Silver Price Could Crash by 20%! - 5th Oct 21
9.Powell: Inflation Might Not Be Transitory, After All - 3rd Oct 21
10.Global Stock Markets Topped 60 Days Before the US Stocks Peaked - 23rd Sep 21
Last 7 days
CATHY WOOD ARK GARBAGE ARK Funds Heading for 90% STOCK CRASH! - 22nd Jan 22
Gold Is the Belle of the Ball. Will Its Dance Turn Bearish? - 22nd Jan 22
Best Neighborhoods to Buy Real Estate in San Diego - 22nd Jan 22
Stock Market January PANIC AI Tech Stocks Buying Opp - Trend Forecast 2022 - 21st Jan 21
How to Get Rich in the MetaVerse - 20th Jan 21
Should you Buy Payment Disruptor Stocks in 2022? - 20th Jan 21
2022 the Year of Smart devices, Electric Vehicles, and AI Startups - 20th Jan 21
Oil Markets More Animated by Geopolitics, Supply, and Demand - 20th Jan 21
WARNING - AI STOCK MARKET CRASH / BEAR SWITCH TRIGGERED! - 19th Jan 22
Fake It Till You Make It: Will Silver’s Motto Work on Gold? - 19th Jan 22
Crude Oil Smashing Stocks - 19th Jan 22
US Stagflation: The Global Risk of 2022 - 19th Jan 22
Stock Market Trend Forecast Early 2022 - Tech Growth Value Stocks Rotation - 18th Jan 22
Stock Market Sentiment Speaks: Are We Setting Up For A 'Mini-Crash'? - 18th Jan 22
Mobile Sports Betting is on a rise: Here’s why - 18th Jan 22
Exponential AI Stocks Mega-trend - 17th Jan 22
THE NEXT BITCOIN - 17th Jan 22
Gold Price Predictions for 2022 - 17th Jan 22
How Do Debt Relief Services Work To Reduce The Amount You Owe? - 17th Jan 22
RIVIAN IPO Illustrates We are in the Mother of all Stock Market Bubbles - 16th Jan 22
All Market Eyes on Copper - 16th Jan 22
The US Dollar Had a Slip-Up, but Gold Turned a Blind Eye to It - 16th Jan 22
A Stock Market Top for the Ages - 16th Jan 22
FREETRADE - Stock Investing Platform, the Good, Bad and Ugly Review, Free Shares, Cancelled Orders - 15th Jan 22
WD 14tb My Book External Drive Unboxing, Testing and Benchmark Performance Amazon Buy Review - 15th Jan 22
Toyland Ferris Wheel Birthday Fun at Gulliver's Rother Valley UK Theme Park 2022 - 15th Jan 22
What You Should Know About a TailoredPay High Risk Merchant Account - 15th Jan 22
Best Metaverse Tech Stocks Investing for 2022 and Beyond - 14th Jan 22
Gold Price Lagging Inflation - 14th Jan 22
Get Your Startup Idea Up And Running With These 7 Tips - 14th Jan 22
What Happens When Your Flight Gets Cancelled in the UK? - 14th Jan 22
How to Profit from 2022’s Biggest Trend Reversal - 11th Jan 22
Stock Market Sentiment Speaks: Are We Ready To Drop To 4400SPX? - 11th Jan 22
What's the Role of an Affiliate Marketer? - 11th Jan 22
Essential Things To Know Before You Set Up A Limited Liability Company - 11th Jan 22
NVIDIA THE KING OF THE METAVERSE! - 10th Jan 22
Fiscal and Monetary Cliffs Have Arrived - 10th Jan 22
The Meteoric Rise of Investing in Trading Cards - 10th Jan 22
IBM The REAL Quantum Metaverse STOCK! - 9th Jan 22
WARNING Failing NVME2 M2 SSD Drives Can Prevent Systems From Booting - Corsair MP600 - 9th Jan 22
The Fed’s inflated cake and a ‘quant’ of history - 9th Jan 22
NVME M2 SSD FAILURE WARNING Signs - Corsair MP600 1tb Drive - 9th Jan 22
Meadowhall Sheffield Christmas Lights 2021 Shopping - Before the Switch on - 9th Jan 22
How Does Insurance Work In Europe? Find Out Here - 9th Jan 22
MATTERPORT (MTTR) - DIGITIZING THE REAL WORLD - METAVERSE INVESTING 2022 - 7th Jan 22
Effect of Deflation On The Gold Price - 7th Jan 22
Stock Market 2022 Requires Different Strategies For Traders/Investors - 7th Jan 22
Old Man Winter Will Stimulate Natural Gas and Heating Oil Demand - 7th Jan 22
Is The Lazy Stock Market Bull Strategy Worth Considering? - 7th Jan 22
METAVERSE - NEW LIFE FOR SONY AGEING GAMING GIANT? - 6th Jan 2022
What Elliott Waves Show for Asia Pacific Stock and Financial Markets 2022 - 6th Jan 2022
Why You Should Register Your Company - 6th Jan 2022
4 Ways to Invest in Silver for 2022 - 6th Jan 2022
UNITY (U) - Metaverse Stock Analysis Investing for 2022 and Beyond - 5th Jan 2022
Stock Market Staving Off Risk-Off - 5th Jan 2022
Gold and Silver Still Hungover After New Year’s Eve - 5th Jan 2022
S&P 500 In an Uncharted Territory, But Is Sky the Limit? - 5th Jan 2022

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

Why do you buy put options and how do you calculate your profit?

InvestorEducation / Options & Warrants Aug 11, 2011 - 06:02 AM GMT

By: Submissions

InvestorEducation

Susan Hayes writes: A put option is the right, but not the obligation, to sell a stock. It is, in essence, an insurance policy on a financial market security.

There are two reasons why an individual or institution might buy a put option;


(a) to protect a stock position (i.e. a protective put);

Let's say that I hold (i.e. long) a stock currently priced at $100. Now, let's say that the lowest price that I want to receive for that stock at some stage in the future (strike date) is $80 (strike price). Options are traded in block of 100 shares in the US market. I could pay a premium (e.g. $1 x 100) to lock in that price via buying a put option. I am buying the right, but not the obligation, to sell that block of 100 stocks at $8000 ($80 x 100) on a certain date in the future. As a result, I have put a "floor" under my stock. Ideally, of course, I don't use (exercise) that option at expiry. I would prefer if the stock rises in value and I can sell the security to the market at a higher price!

(b) To make a return in a falling market;

If a market participant has bought the put option, they are said to be “long” in this transaction. Using the insurance policy analogy, the more risky the scenario insured, the more valuable the insurance contract or "floor" is. As a result, if the stock is falling, the price of the put option goes up. This is a “bearish” strategy i.e. you would only buy a put option if you felt the market was going to fall. This is referred to a “naked” trade if you don’t own the underlying stock and the only reason that you had the option is to make money on the basis that the stock would fall and hence the value of the option would rise.

The maximum amount of loss that a put buyer can have is the premium that they pay at the beginning of the contract. In the numerical example above, all that you can lose is $10 plus your transaction cost. The is an upward limit also – the furthest the share can fall is to $0, at which you would make the maximum of $8000, as this is the difference between the strike price and the market price. In practice, there are a number of things to take into account throughout the life of the option.

Firstly, you need to decide the “strike price” to buy. This is the price that you have the right, but not the obligation to sell at. You might buy an option that is “out-of-the-money” or the strike price is below the current market price. In the above example, you would choose a strike price anywhere below $100. If the stock goes up in value or is still at $100 by the time of the expiry of the option, you will lose your premium and hence, invoke the maximum loss. You may also buy an option that is “at-the-money”, i.e. the strike price is the same as that of the market. Again, if the stock rises or trades flat by the time of expiry, you will lose your premium. However, a trade might start off either “out” or “at” the money and the stock price could fall below the strike price.

In the above example, the price of the share falls below $80. Now this contract is “in-the-money” and you can “exercise” your option. This means that you could sell the stock at the strike price, which is higher than the market price. Have you actually made a profit? Indeed, you might have made money in the difference between the strike and market prices, but you also need to take away the premium that you paid as well as the transaction cost of doing so. Let’s say the market fell to $75 per share. You sold your holding at $80, since you had the put option to exercise. You made a gross profit of $5, but you need to subtract the $1 premium to find the net effect. In fact, you made $4 less the transaction cost from buying this put option.

By Susan Hayes

http://www.facebook.com/...

Susan Hayes is Managing Director of Hayes Culleton – a financial training and educational consultancy company, specialising in eLearning. Susan has a BSc Financial Maths & Economics and passed two of the Chartered Financial Analyst (CFA) exams on the first attempt. Hayes Culleton is a client of Enterprise Ireland as well as a corporate affiliate of Finance Malta. Susan has delivered financial training for Irish Times Training, Malta Institute of Accountants; Bank of Valletta as well as the InvestR Centre. In 2008, Susan wrote a digitised module called “Introducing Wall Street to the Classroom” designed to make the stock market approachable and accessible for second level students and their teachers. She regularly contributes to the national and international media including The Sunday Times (Malta), RTE, Newstalk and Today FM (Ireland), as “The Positive Economist” on matters relating to economics, the stock market, banking, entrepreneurship and finance. Within Susan’s own portfolio, she favours Exchange Traded Funds, Value Stocks and Writing Options.

    Copyright © 2011 Susan Hayes - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in