Options Trading for Beginners – PUT Options Explained for Laymen

Places

Buying a put option on a stock gives the buyer the option (but not the obligation) to sell a specified stock at a specified price until a specified date.

Put options can be used as insurance against falling stock prices. If you bought some shares in a stock and they went up in price when you bought a put option on the stock at the new price, you have, in effect, locked in the stock’s price increase.

Lay Options

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

The 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 Home

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 approached a buyer with a contract (proposal).

Our Contract states that we will give the buyer $1000 for the option (the right but not the obligation) to sell the house at the list price of $100,000.

The contract is good for 30 days and if we do not sell the house within that period, the buyer keeps 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 good for 30 days and if we do not sell the house within that period, the buyer keeps 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 (in the next 30 days) and the house is now valued at $110,000, we let our option expire worthless and we can sell the house for $110,000.

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

o If the housing market crashes (in 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 put contract typically covers a thousand underlying shares (some contracts have odd numbers, so be aware of the number of underlying shares the option contract covers).

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