Wondering how to buy put options? Or what they are? Put options are an investment opportunity that allows investors to lock in a price at which they can sell a particular stock. Put option sellers similarly agree to buy the stock at the agreed-upon price.
This type of investment is often targeted by investors trying to make a significant gain quickly. Conservative investors who are mainly concerned with long-term gains generally stay away from these, but when they are successful, puts can appreciate significantly in value in a short time.
How to buy put options for possible gains
First, it is important to realize that buying too many put options can increase your portfolio’s risk. If you’re going to invest in put options, make sure that you don’t buy excessively. Begin with one or two put options, and grow as you see fit. If you load up your portfolio with a lot of put options and they expire worthless, then you may ultimately lose your entire investment.
If you’re interested in learning where and how to buy put options, your brokerage firm can help you complete your purchase. Put options are sold in increments of 100 shares. The best strategy for investing in put options involves focusing on companies whose shares are likely to decline within three months from the date of purchase. In this scenario, the investor would profit from the difference between the strike price and the price the stock falls to. Let’s look at an example below.
Imagine an investor buys a put option contract of 100 shares. Each share costs $50. After one month, the individual stock price falls from $50 to $40, so the investor exercises the put option. The difference between the strike price of $50 and the current price of $40 is $10. Therefore, the earnings of $10 are multiplied by the 100 shares purchased, making the earnings come out to $1,000.
However, there are also fees associated with put options. The options contract charges a premium of $2 per share. Since 100 shares were initially purchased, that means the total contract charges are $200. Subtracting the $200 from the $1,000 of earnings equates to a total profit of $800.
How to buy put options for a hedge on market declines
Let’s look in more detail to understand how to buy put options. As mentioned above, you need to work with a broker to buy put options. Once you open an account, you’re assigned a trading level. This trading level details the types of trades you can make, and is based on your investing experience, the financial resources available to you, and the risk tolerance you are comfortable with.
Once your account is set up, you’re ready to buy a put option. Again, it is best to start with only one or two . Once you’re prepared to buy, you’ll need to choose a strike price. This price is typically below the stock’s current price. After selecting the strike price, you need to decide upon the expiration date, and how many put contracts you want to buy. The expiration date is usually, at the very least, one month from the purchase date.
Pay attention to the price of your options once the purchase is complete. If the stock price falls below the determined strike price, then the options contract is considered “in the money”. At this time, you can exercise the option and have the option seller buy the contract back at the higher price, leading to profit.
However, if the stock price never goes below the strike price before the expiration date, then the option will expire, no profit will be made, and the initial investment in option costs and fees will be lost.
Is buying put options part of your investing strategy? How have they worked for you during your investment career?