Options Trading For Beginners – PUT Options Explained For Laymen

Places

Buying a PUT option on a share gives the buyer the option (but not the obligation) to sell a given share at a given price through a given date.

Put options can be used as insurance against the price of the stock you own falling. If you bought some shares in a stock and they went up in price by buying a put option on the stock at the new price, in effect you are locked in from increasing the stock price.

Lay Options

I think the home buying analogy is one of the best ways to explain how an option works, so I’ll use that basic premise here.

Cash values ​​are just for simplicity and this will obviously work for different options and stock prices.

Case Study: Buying a Put Option on a House

We have a house that is currently selling for $100,000.

We think house prices may fall but we don’t want to sell the house this month, we are approaching a buyer with a contract (proposal).

Our Contract states that we will give the buyer $1,000 for the option (the right but not the obligation) to sell the house at the list price of $100,000.

The contract is valid for 30 days and if we do not sell the house within that period, the buyer will keep the $1000 and there is no further commitment from either of us.

In fact, we have purchased the equivalent of a month’s put option on the property.

The contract is valid for 30 days and if we do not sell the house within that period, the buyer will keep the $1000 and there is no further commitment from either of us.

In fact, we have purchased the equivalent of a month’s put option on the property.

o If the housing market soars (within the next 30 days) and the house is now valued at $110,000, we let our option expire worthless and can sell the house for $110,000.

$110,000 (Current Value) – $1,000 (Option Price) – $100,000 (Initial Price) = $9,000 (Our Earnings).

o If the housing market crashes (within the next 30 days) and the house is now valued at $90,000, we can exercise our option and sell the house for $100,000.

$100,000 (Sale Price) – $1,000 (Option Price) – $90,000 (Current Value) = $9,000 (Our Locked Value).

contract sizes

On the Australian Stock Exchange, a standard sales contract typically covers one thousand underlying shares (some contracts have odd numbers, so be aware of the number of underlying shares covered by the option contract).

On the New York Stock Exchange, a standard sales contract typically covers one hundred underlying shares.