Put option to buy stock
What if you could buy stocks lower than the current market price? If either of those scenarios sounds appealing to you, then perhaps you should consider selling a cash-secured put. But selling a cash-secured put gives you another method of buying the stock below the current market price, with the added benefit of receiving the premium from the sale of the put.
Sell an out-of-the-money put strike price below the stock price. In order to receive a desirable premium, a time frame to shoot for when selling the put is anywhere from days from expiration. This will enable you to take advantage of accelerating time decay on the option's price as expiration approaches and hopefully provide enough premium to be worth your while. But what you consider a good return is up to you. Ideally, you want the stock price to dip slightly below the strike price, and stay there until expiration.
The premium received from selling the put can be applied to the cost of the shares, ultimately lowering the cost basis of the stock purchase. This is a great scenario. The bad news is you were wrong about the short-term movement of the stock. Plus, the cash you used to secure your put will be available to you for other trades. But look at the bright side.
That would be worse, right? Plus, now that you own the stock, it might make a rebound. This is obviously the worst-case scenario. But what if the stock does completely tank? There are a couple of things you can do. If you doubt the stock will make a recovery, your other choice is to close your position prior to expiration. That will remove any obligation you have to buy the stock. To close your position, simply buy back the strike put. Keep in mind, the further the stock price goes down, the more expensive that will be.
This scenario demonstrates the importance of having a stop-loss plan in place. This is much the same concept as a stop order you might have on stocks in your portfolio. Another use is for speculation: Puts may also be combined with other derivatives as part of more complex investment strategies, and in particular, may be useful for hedging. By put-call parity , a European put can be replaced by buying the appropriate call option and selling an appropriate forward contract. The terms for exercising the option's right to sell it differ depending on option style.
A European put option allows the holder to exercise the put option for a short period of time right before expiration, while an American put option allows exercise at any time before expiration. The put buyer either believes that the underlying asset's price will fall by the exercise date or hopes to protect a long position in it.
The advantage of buying a put over short selling the asset is that the option owner's risk of loss is limited to the premium paid for it, whereas the asset short seller's risk of loss is unlimited its price can rise greatly, in fact, in theory it can rise infinitely, and such a rise is the short seller's loss.
The put writer believes that the underlying security's price will rise, not fall. The writer sells the put to collect the premium. The put writer's total potential loss is limited to the put's strike price less the spot and premium already received.
Puts can be used also to limit the writer's portfolio risk and may be part of an option spread. That is, the buyer wants the value of the put option to increase by a decline in the price of the underlying asset below the strike price.
The writer seller of a put is long on the underlying asset and short on the put option itself. That is, the seller wants the option to become worthless by an increase in the price of the underlying asset above the strike price. Generally, a put option that is purchased is referred to as a long put and a put option that is sold is referred to as a short put. A naked put , also called an uncovered put , is a put option whose writer the seller does not have a position in the underlying stock or other instrument.
This strategy is best used by investors who want to accumulate a position in the underlying stock, but only if the price is low enough. If the buyer fails to exercise the options, then the writer keeps the option premium as a "gift" for playing the game.
If the underlying stock's market price is below the option's strike price when expiration arrives, the option owner buyer can exercise the put option, forcing the writer to buy the underlying stock at the strike price. That allows the exerciser buyer to profit from the difference between the stock's market price and the option's strike price.
But if the stock's market price is above the option's strike price at the end of expiration day, the option expires worthless, and the owner's loss is limited to the premium fee paid for it the writer's profit.
The seller's potential loss on a naked put can be substantial. If the stock falls all the way to zero bankruptcy , his loss is equal to the strike price at which he must buy the stock to cover the option minus the premium received. The potential upside is the premium received when selling the option: During the option's lifetime, if the stock moves lower, the option's premium may increase depending on how far the stock falls and how much time passes. If it does, it becomes more costly to close the position repurchase the put, sold earlier , resulting in a loss.
If the stock price completely collapses before the put position is closed, the put writer potentially can face catastrophic loss. In order to protect the put buyer from default, the put writer is required to post margin. The put buyer does not need to post margin because the buyer would not exercise the option if it had a negative payoff. A buyer thinks the price of a stock will decrease. He pays a premium which he will never get back, unless it is sold before it expires.
The buyer has the right to sell the stock at the strike price.