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Put Option

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What is a Put Option?

Put Option Risk Graph

Put Option

A put option is actually a very common aspect in the modern options trading arena. A put option can be simply defined as a type of security or insurance that an investor buys amidst anticipation that the prices of the underlying stock or indices will go down.  The put option can give the investor a right to sell the shares or indices on the stock upon a certain price and date. The date in financial terms is known as the expiration date while the predetermined price is actually known as the strike price. Options trading in the last few years has seen huge application of puts in the overall process.

As far as using put options while adjusting iron condors, put options can be used as a hedge against a feared drop or market crash. Since there is considerable risk to an iron condor position in relationship to the amount of return that can be made, many iron condor sellers will consider using puts to protect their trading position from a big market drop.

The basic attributes of a put option

The put option can be defined by certain characteristics. Even though some of these attributes may actually have some distinct similarities with call options, they are very distinct to puts also.  To begin with, every put is related to an underlying asset which is normally a stock or index.  Furthermore, every put option also has an expiration date and even though this may seem very obvious to be honest it is a very important factor in trading options using the puts.  A put option also has a distinct strike price this is actually the pre-determined price of the option. Finally the final attribute that is associated with a put is the fact that it is the right to sell unlike a call which is the right to buy. The hardest part about options is that they expire. Incase you dont sell or exercise your option before the expiration date you will lose your entire investment. That’s a scary thought, so you need to take care to always watch your expiration dates. Puts increase in value when the underlying security is going down and decrease in value when it is going up.

Where put options are used

Put options can be used in different financial assets, whilst the common use has been on stocks and indices, today put options are also widely used in commodities trading. In stocks and indices where the market movements have the most impact, investors are keen on using the puts in safeguarding their portfolio from losses. The use of the Puts in the stocks and indices is very obvious and widely applied. How are put options used with commodities, in commodities trading, unlike stocks the assets are not bought out rightly in their physical form. The commodities given their bulk investment requirement can prove very risky and that is where the puts come in. In trading commodities a put option allows an investor the chance to sell a futures contract on the underlying commodity. When you buy a put option, your risk is reduced to the money paid for the put option or the premium and additional commissions and fees.

When is the right time to buy put options?

The best time to trade put options is when the trends in the market for the underlying stock are on the downside.  However, there are times when you can consider to buy put options in case a stock has gone up very fast or there is a prove of future bad earnings.  For instance you think a share is overpriced at $335 a share and you know indeed the stock is destined to drop in the near future, you can buy put options on the stock. The strike price and the expiration month that you choose depend on how far you predict the stock will drop and when. Suppose it is January 1st and your stock is at $335, you have insights that the company which holds the shares is to release the earnings report tomorrow. Furthermore, you have a good understanding that the profits are down. It is possible at this time to buy the stock at a $330 Put for maybe $2 or $200 per contract. It is good to get the nearest expiration month since that would be the cheapest. Furthermore, you will also buy the nearest strike price under the current market price because that is where you tend to get the greatest percentage return. When the news comes out finally the next day that sales were abysmal, the price of the shares will drop to say $300 per share, then your stock $335 Put will be worth at least $35 and you would sell it for $3,500 per contract where you will make a $3,300 profit.  The put is worth $35 because you now have the right to sell 100 shares of the stock at $335 even if the current market price is only $300.

The advantages and disadvantages of put options

The basic disadvantage of put option is the fact that they are not best for long term investments.  The options are just designed for short term monthly gains. Although the options are very effective in safeguarding against loss, sometimes they may be risky especially when after the puts transaction the prices of the underlying stocks go up. The advantages are very clear the first one being the idea that put options have relatively less commissions and can be easily traded by anyone. For net profit, they do have a huge profit potential. Although using the puts in investing on options trading may be easy and implementable at least from a beginners point of view, the reality is a professional approach is needed in order to firmly make it. In that case, the use of an experienced and expert broker with low commission can be invaluable.

Put options and hedging

One of the most common techniques for hedging on a long term stock position is to buy a put option. Contrary to the sale of a call option which is a credit trade, the buying of a put is a debit trade meaning that money is going out. Purchasing a put is actually the same as buying portfolio insurance literally. The money you spend buying the put covers you in the face of potential market disaster.  However if there is no such financial disaster, that money spent is of course gone. It is a proactive measure other than a reactive one. For investors who may be thinking of a secure way to hedge stocks, the use of a put option would be most ideal. The thing is in this scenario, the basic ideas being explored all come to play if there has been a poor performance of the underlying stock. That said it is important to base market analysis on unique factors all of which should be objective and professional.

Developing a good puts options strategy

When coming up with a puts strategy it is best to know and understand the market very well.  The idea of put option only applies if there are reasonable predictions that the market may swerve towards the low affecting prices of the underlying asset. Depending on the expiration date set forth in the month, it is also very important to get acquitted to some of the factors which may lead to change in strategy midway through the expiration period.  A good strategy in put options should be hinged on the need to safeguard your portfolio based on the most recent and professional analysis of the price movements of the underlying stock.

And once again, put options can be very useful to iron condor trades which are in trouble on the downside. By simply adding some very basic option strategies to help in adjusting iron condors, strategies like put debit spreads, put calendar spreads, or even by just purchasing some out of the money put options to act as an overall hedge – iron condor option traders can protect their positions from serious losses and sleep better at night.




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