|
|
Buying Put Options
Two Ways to Benefit from Stock Price
Declines
Buying put options - a contract to sell stock at a specified strike price - can be a good
way to gain from a decline in the market price of a stock while limiting your risk.
Assume you bought a put option for 100
shares, at a premium of $3 and with a strike price of $25. You think the stock price will
drop and it does - to $20. You have two options:
- Exercise the put at your $25 strike
price and, at the same time, buy 100 shares of the same stock at the current $20 market
price. Your earnings will be $200 - the difference between the strike and market price, $5
per share for 100 shares, less the $300 premium you paid to purchase the put option.
- Or, because the put premium would have
ordinarily risen during the contract period, you could simply sell your put option before
the expiration date and collect the difference between the premium you paid upon purchase
and the proceeds you receive upon sale.
Limit Risk with a Married Put
This is another hedging strategy. It means that you buy a put option on a specified stock
at the same time you actually buy the stock. This puts a limit on how low your sale price
can go, even if the price of the stock declines further, during the life of the put. This
strategy is profitable as long as the stock market appreciation is greater than the cost
of the put option.
|
