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Understanding Put Options

 

If you have the chance to talk to anyone in trading, they will tell you that options trading is actually one of the types of trading that has the highest amount of risk. In order to become successful with options trading, it is important to learn the inner workings to gain a deep perspective of the best way to make your options work for you. When you talk of put options, you will need to learn what they are, how you can make a profit with them and how to write them in order to come away with the best possible outcome.

 

Basically speaking, put options are a contract for a derivative of particular index, stock or other security that will allow an investor to sell at a set price otherwise known as a strike price. Generally, the holder of put options has paid a premium for the right but not the obligation to sell. Whenever the market is in a declining state, put options can become profitable. If at any time an investor has put options on a stock that has begun an amount greater than the cost of the premium, they will see a profit.

 

One way that you can become profitable with put options is by trading them. When you find that a put is profitable, they are able to be sold or traded back to the market. The profit is the amount shown on the contract minus the premium. Premiums will increase as the market starts to decline. The increase will allow the investor to have the ability to sell at this time which is known as trading out.

 

Another way that you can turn a profit on put options is by exercising them or selling the stock that you already own. It is the right of any holder of a put to be able to sell the stock at the strike price. For example, if you happen to own a put option that has a strike price of 50 and you know that the market has taken a decline to 40, you would be able to purchase this actual stock in the market for 40 and then exercise the put for 50.

 

To understand writing the contract, whenever you are selling or shorting a put option, you are essentially writing the contract. The seller will collect a premium in hopes that the option expires worthless. The premium will become the maximum gain of the write. With that being said, actually having the option expire is the best scenario that you could ever hope for.

 

Of course, you will see that writing a put option will carry risk. Anytime the option is exercised, you are going to find that the writer has to actually purchase the stock at the strike price from the holder. With any sort of option, you are going to see that timing will be the biggest factor. Put options do expire monthly and they do carry great risk.

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Warren Stockton
 

Warren Stockton is an options trader and writes reviews on options courses, brokers and strategies.

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