Buying Puts. Why Consider Purchasing a Put

This is a straightforward strategy that I have been using for the past few months. It's not something you should use every day, but it can be an effective tool to help manage your portfolio when things are going bad, and you need some extra cash to ride out the storm. The idea behind this strategy is pretty straightforward - buy put options on stocks with low P/E ratios and sell them at higher prices if they start falling. This will allow you to make money even though the stock price has fallen because of the option premium. The best part? You don't need any special software or charts to execute this strategy! All you need is a brokerage account and access to the internet. 


Tips on Buying Put Options

  • Before buying put options, the first thing you want to do is what type of strike price you would like to purchase. If you're looking to profit from short-term movements, you'll probably want to look for calls with lower strikes than those that might give you more time to exit the position. For example, let's say you wanted to go long one month $100 call options against Apple Inc. AAPL. At expiration, these could cost anywhere between $1.50-$

  • 00 per contract depending upon where the market was trading. However, if you were willing to hold onto the positions until March 15th, you'd only pay around $0.75-0.80 per contract. That means you'd get back about 75% of your original investment by selling the contracts at expiration. Of course, there are other factors, such as how much volatility you expect over the coming weeks, etc., but hopefully, this gives you an idea of why you may choose to take advantage of the shorter expirations.

  • In addition to choosing the right strike price, you also need to decide whether to exercise the option early or late. Rolling early allows you to lock in profits while still having enough time to cover your losses. On the flip side, rolling later increases the risk of holding the position since you won't know precisely how far the underlying asset will fall. As always, try to find a balance between taking too little risk versus risking too much.

  • Once you've decided on the strike price and timing, you'll need to determine how many shares you want to own. To calculate this number, simply multiply the current share price by the desired amount of shares. So, if you owned 100 shares of Apple today and you wanted to increase your exposure to 500 shares, you'd just divide the two numbers together: 500 100 x.5. Now all you need to do is add up the total value of each option so you can see how much you stand to gain or lose based on the outcome. Let's assume you bought five $10 calls for a total of $50. Your potential gains would be calculated as follows: 50 + 10 60 Total Value $60 Profit Potential /$50 20%.

  • Finally, once you've determined your trade size, you'll need to select the expiration date. Again, you'll want to consider both the length of time you plan to keep the position open and the level of volatility expected during that period. A longer duration usually results in less overall return due to increased interest rates, whereas a shorter timeframe provides a more significant opportunity for movement. Also, remember that the closer we get to expiration, the more volatile the markets tend to become. Therefore, you'll likely want to avoid putting yourself into a situation where you're forced to close the position prematurely.

  • After selecting the appropriate expiration date, you'll need to set up your online broker account. This process varies slightly depending upon the brokerage firm you use. However, most brokers offer similar features, including margin accounts, stop-loss orders, limit orders, and automated order execution systems. The key here is finding a system that works best for you. Some people prefer using their phone apps because it makes placing trades easier. Others enjoy being able to place multiple orders simultaneously without worrying about getting conflicting instructions. Whatever method you choose, make sure you understand how they work and feel comfortable using them.

Benefits of Buying Puts

  1. You have an easy way to profit from falling stock prices. If you buy put options when the market is down, you are essentially betting against rising stocks. When the market falls, you could potentially earn money off the difference between what you paid for the call option and its eventual sale at a lower price. For example, let's say you purchased one contract of AAPL calls for $2 per share. At some point in the future, those same contracts might sell for only $1.25 per share. That means you'd end up making 25% on every single share sold.

  2. Put buyers often receive credit toward free trading fees. Most significant exchanges allow traders who purchase put options to offset part of their transaction costs through special "put buyer credits programs." These programs typically require investors to pay a small fee but provide significant benefits such as reduced commissions, no minimums, and sometimes even complimentary access to specific research tools. In addition, there may also be tax advantages associated with these types of transactions. Check with your financial advisor before taking advantage of any put buying opportunities.

  3. It allows you to hedge riskier positions. One of the most significant risks facing long-term investors is inflation. As the economy grows over time, consumers demand higher wages, leading to higher prices across virtually everything. You can protect yourself from this type of risk by locking in profits if the underlying asset rises above your strike price by purchasing put options.

  4. They help reduce portfolio volatility. Because options give you the right to sell shares at a specific price, they act as insurance policies against unexpected losses. While many investors worry about losing all or part of their investment capital, put options will prevent you from having to deal with significant declines in value. Instead, you simply collect dividends until the position expires.

  5. They're great for hedging short-term gains. Many investors believe that putting together a diversified portfolio consisting of stocks and bonds provides more excellent stability than relying solely on either asset. However, while this strategy increases overall returns, it comes at the cost of increased exposure to potential losses. To avoid this problem, you can take advantage of put options by selling covered calls to lock in profits when the market has risen significantly. Once the position matures, you can then reenter the markets with confidence, knowing that you won't lose more than you originally invested.

  6. They can save you money on taxes. Since put options expire worthlessly, they don't generate income for shareholders. Therefore, they aren't subject to federal taxation. This makes them ideal vehicles for reducing taxable income.

  7. They offer protection against declining interest rates. Interest rate fluctuations affect most investments negatively because they cause bond values to fall. But since put options expire worthlessly, owners never actually own the underlying securities. Thus, they remain unaffected by changes in interest rates.

  8. They can improve your return/risk profile. The best-performing mutual funds tend to focus heavily on growth strategies.

Cons

  1.  You have limited control over when an option expires. If you want to exercise your rights early, you'll need to find another investor willing to buy back the stock at the same price. Otherwise, you'll end up paying premiums just to get out of the contract.

  2. There's always some degree of uncertainty involved. Even though you know exactly what happens after expiration, you still risk missing out on future gains due to unforeseen events.

Bottom Line

Put options are one of the simplest ways to profit off rising share prices without taking undue risk. In addition, they provide a way to limit downside risk as well as gain tax benefits. For these reasons alone, they should be considered by any serious investor looking to build wealth through the stock market.

The main reason why people use Put Options is to make sure that they do not miss out on the upside when the stock goes up.