Ok not really about the naked put, but now that I have your attention we are going to talk about put options in general. Go ahead and check this post out on derivatives to get up to speed. Wait make sure that you come back. Are you up to speed now? Today I decided to take an in-depth look at the put option and try to explain it in layman’s terms. Sure I cannot cover every possible scenario in this post but I hope to explain it to you and give you a better understanding so next time you hear it you will be able to chime in with your 2 cents.
The put option is a strategy that is seldom talked about among individual investors, but it is a strategy that is popular among savvy investors and options traders. The put buyer pays a premium to the seller for the option to purchase the underlying security. (no pun intended, ok it was!)
What is a put option?
A put option simply is an option that gives the buyer the right, but not an obligation, to sell the underlying security at a certain price and certain time. If the buyer decides to exercise the seller of the put option has to purchase the underlying security at the strike price if the buyer exercises the option. The put option is sold in 100 share increments. American put options can be exercised any time prior to the expiration date. The expiration date for American put options is the third Sunday of every month. Confused? Great I will provide an example later.
Why would you enter into a put option?
A buyer thinks the price of the security will decrease by the exercise date. The buyer pays a premium.
A writer/seller thinks that the price of the underlying security will increase and collects the premium
Example of a Put Option:
With all the bad press recently that Groupon has received, we expect the price of the shares to decline. We buy a put option with a strike price of $11.00. We would start to make a profit once the price of the shares falls below $11.00. We are trying to catch the profit off the downward movement of the underlying security.
Trading this type of financial instrument we are using leverage, while this situation we anticipate a positive outcome, there can be severe consequences using any type of leverage. It is best to seek out a financial advisor before using options on your own.
Class are you ready to explore put options on your own? Have you had any practice trading options on your own? Were you successful at it?