How to use options correctly
Close vs. Exercise Investors may buy put options when they are concerned that the stock market will fall.
That's because a put—which grants the right to sell an underlying asset at a fixed price through a predetermined time frame—will typically increase in value when the price of its underlying asset goes down. If you own a put, you will benefit from a down market—either as a short speculator or as an investor hedging losses against a long position. So, whether you own a portfolio of stocks, or you simply want to bet that the market will go down, you can benefit from buying a put option.
Key Takeaways A put option gives the owner the right, but not the obligation, to sell the underlying asset at a specific price through a specific expiration date. A protective put is used to hedge an existing position while a long put is used to speculate on a move lower in prices.
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The price of a long put will vary depending on the price of the stock, the volatility of the stock, and the time left to expiration. Long puts can be closed out by selling how to use options correctly by exercising the contract, but it rarely makes sense to exercise a contract that has time value remaining. Buy A Put! Protective Puts If an investor is buying a put option to speculate on a move lower in the underlying asset, the investor is bearish and wants prices to fall.
On the other hand, the protective put is used to hedge an existing stock or a portfolio. When establishing a protective put, the investor wants prices to move higher, but is buying puts as a form of insurance should stocks fall instead.
If the market falls, the puts increase in value and offset losses from the portfolio. Opening a long put position involves " buying to open " a put position.
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Opening a position is self-explanatory, and closing a position simply means buying back puts that you had sold to open earlier. Long Put. Short sellers borrow the shares from their broker and then sell the shares.
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If the price falls, the stock is bought back at the lower price and returned to the broker. The profit equals the sale price minus the purchase price.
In some cases, an investor can buy puts on stocks that cannot be found for short sales. Some stocks on the New York Stock Exchange NYSE or Nasdaq cannot be shorted because the broker does not have enough shares to lend to people who would like to short them. Importantly, not all stocks have listed options and so some stocks that are not available for shorting might not have puts either.
The distinction between American and European options has nothing to do with geography, only with early exercise. Many options on stock indexes are of the European type.
In some cases, however, puts are useful because you can profit from the downside of a "non-shortable" stock. Like all options, put options have premiums whose value how to use options correctly increase with greater volatility. Therefore, buying a put in a choppy or fearful market can be quite expensive—the cost of the downside protection may be higher than is worthwhile.
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Be sure to consider your costs and benefits before engaging in any trading strategy. The distinction between the payoffs for a put and a call is important to remember. When dealing with long call optionsprofits are limitless because a stock can go up in value forever in theory.
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Exercise Closing out a long put position on stock involves either selling the put sell to close or exercising it. Options on stocks can be exercised any time prior to expiration, but some contracts—like many index options—can only be exercised at expiration.
The value of a put option in the market will vary depending on, not just the stock price, but how much time is remaining until expiration. This is known as the option's time value. In this case, it is better to sell the put rather than exercise it because the additional 50 cents in time value is lost if the contract is closed through exercise.