Buying Puts

As we have already seen in some examples, when you buy a put it is because you have a bearish view of the market. The underlying asset is expected to go down in price, and the put contract is expected to go up.

Those who buy a put have the right to sell shares at a price defined by the strike before maturity. They expect the market to go down, and are willing to pay a premium, to ensure the sale. This is if you own the shares (or plan to buy them to exercise the contract), but if you don’t own shares or don’t want to buy them you can buy a put contract and then sell it before maturity.

Buying Put Example

For example, ABC shares are at u$s29 and you think it is time to buy a put with strike 30 at u$s3 per share (i.e. u$s300 the contract) at a certain maturity, as the company is doing very badly and they are having legal problems, influencing the prices. We also note in the technical analysis that there are bearish probabilities.

Let’s assume that everything went well and the share price went down to $24. And the contract is now worth $6:

1. You don’t own the stock, you just want to sell the contract:

Contract premium investment: 100xu$s3=u$s300

Selling the contract: 100xu$s6=u$s600

Profit: u$s300

2. You have the shares, and you exercise the contract: If you do not have the shares, you must first buy them. As it was 1 contract, in this case you buy 100 shares and then sell them at the strike price.

Premium contract investment: 100xu$s3=u$s300

Purchase of the shares: 100xu$s24=u$s2400

Sale of the shares: 100xu$s30=u$s3000

Ganancia: u$s3000-u$s2700=u$s300

As you can see, in this example the same profit of u$s300 is obtained in money, but the percentage of return on the investment is different. This is the leverage effect. Therefore, with less money, we earn the same with the purchase and sale of the put contract.

Why do you buy a Put Option?

The purchase of puts can be used as a hedge if the shares in the portfolio fall, as an investment to obtain a return on the purchase and sale of the contract without holding the shares or as protection if the shares in the portfolio fall in the short term, but want to be preserved for the long term. It is therefore a widely used strategy in the trading world.