Investing via the Put Option

Let’s revisit Puts and Calls.  We talked about this back on December 8, 2011.  I think it’s time to expand on the subject with some different strategies and additional examples.

Go here for a refresher on the definitions if you haven’t used a Put or a Call in your investment strategies.

Ok, let’s expand upon the subject.

If you need some encouragement, buying Puts and Calls can definitely make more profit for you than if you buy the stock at face value.  There is some risk, but you should not be in the equity market if you are afraid of risk.  How does doing this make more profit?  See the example below.

Let’s explain.  First of all you will need to sign an Option contract with you broker.  This authorizes them to act on your behalf to buy or sell stock at a reference price during a set time frame.

This time we will tackle the Option to Put (or Put Option).

Even though this strategy is a legal and viable way to invest your money, I personally have a slight philosophical conflict with it.  You see, investing in the market using a “Put Option” is akin to profiting from your neighbor losing their house or job.  It is negative rather than positive thinking – in my mind.  Given that, let’s learn a little bit about it.

The same terms are used in this Option as were used in the Call Option.

The reason to buy a put option is based upon your expectation that the price of ABC stock will fall from its current value and it will fall soon.

The Trade works like this:

It is early June and the price of the ABC company stock is at $39 per share.  You expect that their stock will fall because of expected poor earnings, so you chose to buy a Put Option for $3 per share with the strike price set at $40 and having a July option.  Remember that the put option is for 100 shares, so you spend $300 to own this put option.

You, as the owner now have the right to sell 100 shares of ABC stock at $40 per share any time before the close of trade on the Third Friday of July.  Note: currently you need the stock to fall drastically because you spent $3 per share and if no change in stock price you will spend another $1 per share based on stock value.  You can see your risk here.

Let’s say your intuition is correct.  The earnings report comes out and was poor, extremely poor.  The stock starts to fall.  During your time frame, the value of ABC stock drops to $30 per share and seeing your opportunity, you sell your option.  How much do you make?

Valuation

$40 – $30 = $10 per share

100 x $10 = $1,000.00

Less Purchase

$3 per share

100 x $3 = $300.00

You Made

$7 per share

100 x $7 = $700.00

Stock Lost

$39 – $30 = $9 per share

100 x $9 = $900.00

You can see that by using the Put Option, you made $700.00 while the stock lost $900.00.  What a deal!  What happens if the stock doesn’t go down?  I will discuss this in the next article.

Gary

About Gary

I am retired, but not tired. I still want to be valuable to others. I know that others are valuable to me. After looking back on six decades, I have asked myself this question: “What do I believe?” My mind filled up. My heart started beating faster. My spirit soared. I post blogs to share what my mind is working on, what my heart believes would help others and, what my spirit is communicating to me. What do I believe, you ask? Decisions dictate your path In love, not hate In tolerance, not prejudice In health, not sickness In wealth, not poverty In kindness, rudeness In happiness, not sadness In encouragement, not discouragement In faith, not doubt In courage, not fear I have been and will be challenged in each one of these beliefs, but the biggest belief is to stay positive and not turn negative. This belief helps me maintain all of the others.

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