Put Options
Buying a put option means you want the market to go down. The money paid for the put is called premium. The total
risk for an option buyer is the amount of premium paid plus commission and fees.
Most option traders will use calls and puts to make simple directional trades in the market. If you want the market
to decrease in value then buy a put. Advanced traders will use an option to obtain the underlying issue, a stock,
commodity or currency contract. You can exercise a put to sell an underlying asset.
Familiar terms for put options
- Expiration: The expiration is the date when the option expires. If an option is out of the money at expiration
then it is worthless. Most of the time expiration is stated in terms of month and year. A December 2004 Corn put,
or a March 2005 Wheat put are two examples.
- Premium: The cost of the option expressed in points or dollar amount.
- Strike Price: This is the stated price at which a buyer of a call has the right to
purchase a specific futures contract or at which the buyer of a put has the right to sell
a specific futures contract.
Risk profile
The risk for purchased puts is the amount of premium paid for the option plus all trade fees associated with the
trade. All of your investment is at risk until the market declines below the strike price of your option. At exercise
if the market is trading above the strike price then your option is worthless and you loose 100% of your investment.
A 230 Corn put is worthless on expiration day if the price of Corn is above 230. Below the strike price the put
makes 100% of the move of the underlying issue at expiration. A 230 Corn put is worth 10 points on expiration
day if Corn is trading at 220.
Risk of Exercise
If a purchased put option is in the money (the market price is below the strike price) then your option can be automatically
exercised by the exchange. At exercise the option holder will receive a short futures contract at the strike price of your option.
A March 230 Corn put would exercise into a short March Corn future at 230 if the price of March Corn is below 230 on expiration day. One important
note, when your option is exercised you will need to have sufficent funds in your account for the margin requirement.
Option Values Before Expiration
At expiration options are worth 100% of intrinsic value. Prior to expiration options can be worth more or less than
their intrinsic value. Various market forces act on option prices prior to option expiration. Some of these forces
are time before expiration, market volatility and interest rates. For example an important government report could
cause a market to drop tremendously. Put option values for this market could jump considerably in response to the
news announcement.
Calculating the breakeven for a put option at expiration
The breakeven of a put is the strike price minus premium paid in points minus any trade fees. A 230 Corn put
bought for 5 points has a breakeven of 230 (strike price) - 5 (option premium) or 225 minus trade fees. Assuming it costs
1 point for trade fees, then your breakeven would be 224. At expiration the market must be lower than 224 to pay back the
original cost of the option (5 points) plus transaction costs (1 point).
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