Next decide how many contracts to buy. Each options contract is for shares of stock. For each contract you will pay the listed premium for that option, plus brokerage fees. You can exercise the option at any time before the expiration date.
If current prices fall below the strike price, the option is considered in the money. If your option is in the money, you can require the writer of the option to purchase your shares at the higher strike price. But you have to buy the shares before exercising the that uncovered put option. You can buy put options on indexes as well as individual securities. This can produce profits from broad declines in bear markets. Of course, the share prices might not decline below the strike price.
Then the put option buyer would let the option expire unused. Buying uncovered put options gives an investor lots of leverage.
Buying put options can be a simple and less risky way to trade options. We are an independent, advertising-supported comparison service. Our goal is to help you make smarter financial decisions by providing you with interactive tools and financial calculators, publishing original and objective content, by enabling you to conduct research and compare information for free - so that you can make financial decisions with confidence.
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Options are a type of financial instrument known as a derivative because their value is derived from another security, or underlying asset. Here we discuss stock options, where the underlying asset is a stock. For this option to sell the stock, the put buyer pays a "premium" per share to the put seller. Each contract represents shares of the underlying stock.
If you think the market price of the underlying stock will fall, you can consider buying a put option compared to selling a stock short. If you think the market price of the underlying stock will stay flat or move up, you can consider selling or "writing" a put option. For a put buyer, if the market price of the underlying stock moves in your favor, you can elect to "exercise" the put option or sell the underlying stock at the strike price. American-style options allow the put holder to exercise the option at any point up to the expiration date.
European-style options can be exercised only on the date of expiration. Buying and selling put options can be used as part of more complex option strategies. Put options can function like a kind of insurance for the buyer. A stockholder can purchase a "protective" put on an underlying stock to help hedge or offset the risk of the stock price falling because the put gains from a decline in stock prices. But investors don't have to own the underlying stock to buy a put. Some investors buy puts to place a bet that a certain stock's price will decline because put options provide higher potential profit than shorting the stock outright.
The buyer has two choices: First, if the buyer owns the stock, the put option contract can be exercised, putting the stock to the put seller at the strike price.
This illustrates the "protective" put because even if the stock's market price falls, the put buyer can still sell the shares at the higher strike price instead of the lower market price.
Second, the buyer can sell the put before expiration in order to capture the value, without having to sell any underlying stock. Then the put seller keeps the premium paid for the put while the put buyer loses the entire investment. The graph below shows the put buyer's profit or payoff on the put with the stock at different prices. The other is short selling. The difference between the sell and buy prices is the profit.
There's a reason why put buyers get excited. Buying puts offers better profit potential than short selling if the stock declines substantially.
In contrast, short selling offers less profitability if the stock declines, but the trade becomes profitable as soon as the stock moves lower. The biggest advantage for short-sellers, though, is that they have a longer time horizon for the stock to decline. While options eventually expire, a short-seller need not close out a short-sold position, as long as the brokerage account has enough capital to maintain it.
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