Trading put options is the secret to making money when stocks fall in price. You often make more money trading put options because stocks fall faster and harder than they rise.
As we talked about in the earlier lessons, put options allow you to potentially sell something for MORE than it's worth. The buyer has the right, but not the obligation, to sell shares of a stock at a specified price on or before a given date.
So let's look at how this plays out with a real stock trade.
Put options give the buyer the right, but not the obligation, to sell shares of a stock at a specified price on or before a given date.
For instance if you bought an IBM January 130 "Put", the option (contract) gives you the right to "sell" IBM stock for a price of $130 on or before the third Friday of January.
If IBM falls below $130 before the 3rd Friday in January you have the right to sell the stock for more than its market value.
So let's say that IBM falls in price to $76. Everyone else who owns the stock has to sell it for $76, but you own a contract that says you can sell it for $130!
***You hold a contract that says you get to sell something for more than its market value***
Someone who owns a great deal of the stock and is facing the pressure of selling it at $76 would love to own a contract that says they could sell it for $130.
Do you think they might be willing to buy that contract from you? Yup they sure would.
Now can you see why Put contracts go "up in value" as the underlying stock goes "down in price"? The further the stock falls below your strike price ($130), the more valuable the option becomes.
Let's pretend that IBM was trading at $200 a share. Your options contract would not be as valuable. Who would want to buy a contract from you that gives them the right to sell the stock for $130 when they could easily sell it for $200 a share on the open market?
No one, which is why Put's "decrease in value" as the "stock price rises".
So when an individual believes that the price of a stock is going to fall, they can profit from this movement by purchasing a Put Option.
You can cash in by either selling the Put at a profit, or by exercising the option and then selling the stock.
Using the option's actual historical prices here is how the IBM trade would have looked if a trader decided to sell his/her Put:
The amazing part about this example is that these are the actual prices from the option chain. These are also the kinds of trades that make me sick to my stomach because I discover them after the fact.
Since the option contract is in-the-money (ITM) another choice would be to exercise the option:
As you can see in the example, the profit is the same whether the option is traded or exercised.
Another point to note is that when an option is in-the-money (ITM), its option price "generally" moves dollar for dollar with the stock price movement. This applies for both Puts and Calls.
The percentage returns are different because in the first example you only had to risk or commit $900 to make $5,400, but in the second example you had to risk or commit $7,600 to make the same $5,400.
I don't know what has brought you to my page. Maybe you are interested in options to help you reduce the risk of your other stock market holdings.
Maybe you are looking for a way to generate a little additional income for retirement. Or maybe you've just heard about options, you're not sure what they are, and you want a simple step-by-step guide to understanding them and getting started with them.
I have no idea if options are even right for you, but I do promise to show you what has worked for me and the exact steps I've taken to use them to earn additional income, protect my investments, and to experience freedom in my life.
If you want to learn more, I invite you to download a FREE video case study on how to trade options like Warren Buffett.
Inside you will discover...
Fill in your details below to download your FREE case study. Along with your case study, you'll also get my daily emails where I share my favorite option trading strategies, examples of the trades I'm currently in, and ways to protect your investments in any market.
Wealth Building Resources
Free Video Case Study (Newsletter)
Options Trading Made Simple Book (My Kindle book)
Options Wealth Academy (High End Training Program co-founded by Travis)
Free Options Course Learning Modules
Module 1: Option Basics
Module 2: Option Value
Module 3: Basic Strategies
Module 4: Stock Charts
Module 5: Technical Indicators
Module 6: The 7-step process I use to trade stock options
Learn Stock Options Trading Home Page
Trader Travis's YouTube Channel