Understanding put options

Put options are one of the most important concepts to understand if you plan on becoming a stock market trader. The real benefit they offer is their ability to help out all kinds of traders.

Whether you are a long term buy and hold trader or you are looking for an explosive short term growth put options will help you. First let us look at what exactly a put option is.

A put option gives the buyer the right to sell a stock at a given price on or before a given date at a given strike price. For example a June $55 put on XYZ will give the buyer the right to sell stock XYZ at $55 by the third Friday of June. There are 2 ways you may want to buy puts.

1. Protecting your positions. Stock XYZ is trading at $60. The market has been volatile lately and you are afraid it might tank. If it does you will lose your shirt. To prevent it you decide to buy the $55 put for $2.

This $2 allows you to sleep at night. If the market crashes and your $60 stock becomes a $20 stock you can rest assured you will be able to sell it at $55 because you bought insurance on it. You also benefit if the market rallies and your stock shoots up to $100 because you are not obligated to sell at $55.

2. Taking advantage of a big move. If you believe the stock is going to fall down to $45 buying the $55 put for $2 could be a great speculative play. Think about it if you are right your put option would be worth at least $55-$45 or $10. That would give you an $8 or 400% profit if you are right and only a $2 loss if you are wrong. This is a highly speculative way to trade but can pay off big if you are right.

Of course there are two different parts to every trade. For every buyer there has to be a seller. While put options give the buyer the right to sell at a given price it also gives the seller the obligation to sell at that price if the stock is lower than the strike price.

So why would anyone want to sell puts? There are also 2 ways why someone would want to sell put options.

1. To become the insurance company. How many of you Wright checks to your insurance company. By selling puts you can actually be the one receiving the checks. Let us say someone else owns stock XYZ. It is trading at $60 and they are afraid it could fall so they buy the $55 put for $2 to protect them.

You look at the stock and you believe it is going to head up or at least stay above $55. In this case you sell them the $55 put for $2. You walk away with $2 but are obligated to buy the stock if it goes below $55. This can produce consistent income but also can produce huge losses if you are wrong. Because of this you should always be careful when becoming the insurance company and only sell puts on stocks you are 100% confident it will not come crashing down.

2. Getting paid to get into a stock. Remember the downside of selling puts is you might be forced to buy a stock. But for some people that is not such a bad idea. If you are bullish on a stock you could always decide to sell a put collect the premium and be forced to buy the stock at the strike price of the put.

This option can leave you happy on all areas. If you get put to the stock you will have effectively gotten paid to do something you wanted to do anyway. If the stock heads up you will have missed getting into the stock but walked away with the put premium.

Put options offer something for everyone. Depending on your trading type you may prefer one put trading strategy over another but like always the more you know the more you can make.

For more information about puts options visit http://www.stocks-simplified.com/put.html

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