Buying Put Options Explained

Options trading is a popular way to earn money in the financial industry. It allows investors to speculate on the future price of various assets. Options are essentially contracts that use an underlying asset. Investors can then bet on the future price of the asset. They speculate if it will go up or down, by how much, and when.

With that said, there are two types of options — put options and call options. Today, we are focusing on put options, as having puts explained properly can be priceless to new traders and investors.

What Is a Put Option?

Put options — also called “puts” — are special trading contracts. They offer the buyer the option to sell a specific amount of the underlying cryptocurrency within a specific time period. They also specify the so-called  “strike” price. The buyer of the put option is not obligated to sell, but may exercise their right to sell. That right is defined by the conditions of the contract.

Put options are essentially the opposite of call options. They provide their owners with the option to buy (as opposed to sell) the underlying asset, like a coin or token. However, cryptocurrencies are only one type of underlying asset that can be used. They have an expiration date, and the sale is performed for a specific strike price, like with puts. 

Of course, this only scratches the surface, and to have puts explained properly, we have to dig deeper.

Puts Explained: How Does a Put Option Work?

Put options allow you to sell the underlying asset, such as cryptocurrency, stock, or something else of value. They are in the money when the asset’s price is under the strike price when the expiration date arrives. With options, the trader has no obligation to buy or sell, and that is what makes them popular. 

The put owner is free to sell the stock at the strike price, as well. Or, they can sell it to another buyer before the expiration. Options are quite flexible, and they are relatively easy to profit from. You profit when the premium paid is lower than the difference between the strike price and the asset’s price. Of course, this is only the case at the moment when the option expires.

How Do Put Options Make Money?

The way put options make money is fairly simple. Let’s assume that a trader purchases a put option for a premium of $0.80. Let’s also assume that the strike price for the contract was $30. If the underlying asset’s value reached $25 when the option expired, then the put’s price is $5. Removing the original payment of $0.80 (premium), the trader gets to keep $4.20 as pure profit.

If, on the other hand, the price ends up being $35, for example, then the put expires worthless. In that case, the trader would lose their original premium of $0.80. Of course, this is not a problem if the trader only uses small amounts. But, it can become an issue if they go for larger figures.

Advantages of Put Options

The greatest advantage of buying put options is earning a profit when the stock price drops. The trader pays only a small premium upfront; if the stock market keeps crashing, they can earn quite a sum. As such, buying puts serves as insurance from stock decline. However, to ensure profits, you must first predict the market behavior properly.

Another advantage is that you can also sell the contract itself to someone else at any point. If you happen to change your mind, all you need is a buyer who believes that the price will drop. Put options are a good way for investors to hedge, too. Those who have shares in a particular stock can buy puts to minimize their losses if the stock crashes.

Buying and selling depend greatly on your option strategy, too, which can be another way to use puts. If you have a solid option strategy, you can cover all possibilities. That way, you can still come out on top, no matter what happens.

Disadvantages of Put Options

Unfortunately, puts can also do damage if you miscalculate. If the price goes in the opposite direction from what you expected, you can lose your premium. More often than not, those who sell options can experience the greatest damage from it. Option buyers, on the other hand, only risk the premium that they already paid.

Put Options vs. Call Options

So far, we have covered a lot about options trading if you choose puts. However, if you choose calls or call options, you are doing the opposite. Calls represent your right to buy the underlying asset at a specific price. Like puts, they have an expiration date, as well. They also require you to pay a premium, which is just a small fee, usually.

The two share similar risks, but they are the opposite of one another. In both cases, you need the price to reach a certain level and go beyond. The only difference is the direction in which the price will go. The amount that the price will move matters also, and so does the time period when it moves. 

In other words, calls and puts are the two sides of the same coin.

Put Options vs. Short Selling

Another alternative to puts is short selling, also known as shorting. This is a similar strategy to what you do with options. In other words, you use it when you expect that the price of the underlying asset will go down. With shorting, you essentially bet that the price will go down, and if you are correct, you make a profit. 

Shorting involves selling assets that you do not actually own. As such, they are borrowed from the market. Shorting serves as a way to tell the market’s expectations for specific assets. If traders see that many people are shorting a certain stock, they might sell it or avoid buying it. They will assume that others expect the price of the stock to drop. 

The biggest difference between the two is that puts do not come with the obligation to buy the asset. Once again, you are purchasing the right to sell, but it comes without the obligation.

One aspect that the two share is risk. As you may know, long-term expectations for any market is that the prices will go up. So, shorting and puts are typically the safest to use in short-term trading. In both cases, you make money if the underlying asset’s price drops. So, having it go up is not a good development for puts and shorting practitioners.

Are Put Options a Good Choice?

Traders around the world use puts when they expect a price drop of a certain asset. With that in mind, it is important to have puts explained, especially for new traders.

With puts, they can hedge if they have ties to the asset. Alternatively, they can profit from its losses if they don’t. As such, they are a useful tool for traders of any asset out there. Of course, they come with certain risks. The biggest risk is the market taking an unexpected turn. If this happens, then your prediction is wrong, and you can experience losses.

Since you have no obligation to go through with the contract, you will only lose your premium in that scenario. This minimizes the risk, as you can simply let the contract expire worthless. Still, any loss is a loss, no matter how small. With that in mind, it is best to work on your prediction and apply strategies to prevent losses completely.

FAQs

What Is a Put Option?

A put option is a contract that gives you the right, but not the obligation, to sell an underlying asset. Traders use puts when they expect the asset’s price to go down. With the price drop, a trader earns money, assuming that they made the right prediction.

How Do You Make Money on a Put Option?

You make money by choosing a price different from the strike price. However, in order to actually profit, the difference between the two prices must be bigger than the premium you paid. It can be a bit tricky for new traders to find that balance.

Why Would You Buy a Put Option?

One buys put options when they expect the price of an underlying asset to drop. Puts can help you profit from a crashing market or hedge against it. They serve as insurance from negative price movement.

What Happens if a Put Option Goes Up?

In that case, the option will expire worthless. You are under no obligation to go through with the contract, but you will lose your premium. While this is a negative scenario, it will still let you minimize the losses.

Can You Sell a Put Option Early?

You can sell a put option early, but then you sell at the strike price. Alternatively, you can sell the contract to another buyer. That way, they will take your place as the contract’s owner.

What Are the Types of Put Options?

There are several types of puts, including long put, short put, protective put, and bear put spread. Each has its own strengths and weaknesses, and each is useful within a specific market situation. They can also be considered put option strategies.