The profit on a put is limited as the price of the
underlying stock can never fall below zero.
Loss
The loss on a put is limited to the price of the
premium paid.
Break Even
The break even price is the strike price minus the
premium.
Put Strategies
Buying a put is almost the opposite of buying call - it would be recommended
when the outlook on a
particular stock is for its price to go down.
When you purchase a put option, though, you have the right (but not the
obligation) to SELL 100 shares of the underlying stock at a specified
price at any time before a specified date (as opposed to call option
which gives you the right to buy the shares).
:: Trading Condition
Stock
Dell
Price
$30.00
Outlook
Near term bearish
:: Alert Example
Action
Buy 4 Puts
Strike
$30.00 (ATM)
Premium
$0.85
:: Profit Scenario
As the stock price falls it will approach the
break even point, which is $29.15 (the strike price of $30 minus the
$0.85 premium). Once the stock has passed this point you are in
profit, and the expectation of the advisor would be for the price of
DELL to go below $29 before the expiry date of the options.
When the stock reaches $25, the advisor recommends selling. At
this point, the options would be trading for around $5.00 (strike price of $30 less
the current stock price of $25). Your profit would
be $1,660:
Cost Per Contract
$0.85 x 100 = $85.00
Total Trade Cost
$85 x 4 = $340
Profit Per Contract
($5.00 - $0.85) x
100 = $415
Total Trade Profit
$415 x 4 = $1,660
:: Loss Scenario
If the advisor is wrong, however, and the price of the
stock rises to $35, the price of your put options would also decrease. As
the expiration date approaches time decay will erode their
value, in which case the recommendation would probably be to limit
your losses by selling the options and moving on to the next trade.
As with buying calls, those losses are always limited to the premium you paid for the
option.
