Put option to buy stock
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. Selling cash-secured puts is a substitute for placing a limit order on a stock you wish to own.
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.
The writer receives a premium from the buyer. If the buyer exercises his option, the writer will buy the stock at the strike price. If the buyer does not exercise his option, the writer's profit is the premium.
A put option is said to have intrinsic value when the underlying instrument has a spot price S below the option's strike price K. Upon exercise, a put option is valued at K-S if it is " in-the-money ", otherwise its value is zero.
Prior to exercise, an option has time value apart from its intrinsic value. The following factors reduce the time value of a put option: Option pricing is a central problem of financial mathematics. Trading options involves a constant monitoring of the option value, which is affected by changes in the base asset price, volatility and time decay. Moreover, the dependence of the put option value to those factors is not linear — which makes the analysis even more complex.
The graphs clearly shows the non-linear dependence of the option value to the base asset price. From Wikipedia, the free encyclopedia. This article needs additional citations for verification. Please help improve this article by adding citations to reliable sources. Unsourced material may be challenged and removed.
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