Put Options Explained

by Wes Bridel on April 29, 2011

in Stewardship

How Are Put Options Different from Call Options?

Obviously, as you read last week, Put Options are completely different from Calls.  But we wanted to demonstrate how the price changes move.  This post won’t make any sense if you haven’t read the series which starts here.  Let’s look at a Put Option Chain example and then explain how they are priced…

Puts for Dec 18 2010

Last Change Bid Ask Volume Open Int Strike

0.11     -0.07          0.11 0.12 3,086               22,788              26

1.09     -0.13           1.08 1.10 382                  2,358               28

3.10     -0.10           2.98 3.05 174                  1,495               30

You can see above that instead of the prices going down as strike prices move up, the prices are going up as strike prices move up.  This is because the profit and risk of a put option is opposite that of a call option.  When you buy a put option, you are buying the right to sell a stock at a certain price on a future date.  Thus, there is a greater chance that this will be a profitable option and the price of the option should reflect that.

For Call Options, the lower priced options were “in the money” and had a price roughly equivalent to the difference between the strike price and the current price of the stock (MSFT).

Here, in the case of Put Options, the higher strike price options are “in the money” and have a price roughly equivalent to the difference between the strike price and the current price of the stock (MSFT).

The $26 Strike price Option is “out of the money” and thus selling at a much smaller price.

Let’s make one more thing clear before we start discussing how to use options to increase your income and lower your risk on stock positions….

Closing a position

Of course, you don’t have to hold any option to maturity.  You can exit the transaction at anytime by doing the opposite of what you did to get into the transaction.  So if you had bought a Call Option.  You can choose to “Sell to Close” the same Call Option.

If you had sold a Put Option, you can choose to “Buy to Close” the same Put Option.  You can do the same thing with to close a sold Call Option or a Bought Put Option.

This is Post 5 of a new series on stock options which we’ll be revisiting every few days.  You can find the first few parts at the following links: Pt 1, Pt 2, Pt 3, & Pt 4.  You can check out the series we just finished on professional money management and funds by following these links: Pt 1, Pt 2, Pt 3, Pt 4, Pt 5, & Pt 6.

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