In the first part of this 2 parter, I described how to profit in a falling market via short sale. In this part, since I will be typing about the put option.
Let's say our bogus company XYZ also trades options. I feel XYZ for whatever reason is going to fall from here. XYZ is trading at $10 a share and I also see it trades options. The put option to sell 100 shares for the strike price of $10 that expires 3 months from now costs about $1 a share.
Now that is $100 per contract Ill be paying. I had $1000 to throw at the position so I'll buy 10 contracts.
XYZ falls to $7.50 a share. my options went from $1 to $3.25! now my options position is worth $3250! $2250 is a far cry from the $250 pocketed shorting the shares!
Assume now XYZ falls another $2.50 to $5 a share. I sell out my options which now are at $5.05 per share times 10 100-share contracts gives us $5050.. over five times my money!
So options give you another way to profit when a stock's share price drops, without having to borrowing anything from anyone. Not only that but options are also time leverage (not debt leverage) which give you the option to leverage many times a gain or loss in a stock. Put options like the one in this example can also actually protect you from loss by locking in your right to sell at the higher price.
Options are to be only used by those who know how to trade them! You can think of trading shares as conventional weapons, but by comparison options are nuclear weapons! As with all weapons, you can do great harm to yourself if you do not use them properly. I will dive further into them in a future post, explaining the basics.
