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Options Trading Strategy:
Buying Puts

Buying calls or puts are the most popular options trading strategies among retail traders. There are no margin requirements for this type of trading and an options investor can try buying puts or calls with a relatively small portfolio.

If an options trader is expecting the market to drop down he/she can buy puts with expectations to profit from a bearish movement. A put gives to the owner the right, but not the obligation, to sell an asset at a specific price (the strike price), on or before a specific date (the expiration date). If the price of the underlying stock goes down, the put price goes up.

For example, if you buy a QQQQ options put at $2.00 and the next day QQQQ stock drops 1%, your puts may increase in value by 20%. You may then decide to sell the puts and fix a 20% profit, or if your view on the market is still strongly bearish you may decide to wait and sell the puts later, in expectation of bigger profits. On the other hand, if after buying QQQQ put options the QQQQ stock went up, then the value of the bought put options will decrease.

An options buyer should always be aware that time plays against him. Even if the market moves flat, the value of the puts may drop within a couple of days. The closer to expiration the puts are the more sensitive they are to the time factor.

The maximum loss a put options buyer may experience is 100% of the amount invested in the put options. The potential profit is theoretically unlimited.

Depending on the trading style and risk tolerance, an options buyer may chose to buy different types of put options that may vary by strike and expiration. The most traded options are nearest in the money put options. They are considered more or less safe and the reaction of the options price to the changes in the price of the underlying stock is still big. The deeper in the money put options are considered more conservative; however, they are more expensive. The cheaper (out of the money) put options are considered more risky and the cheaper (more out the money) they are, a bigger move in the underlying stock is required to trigger changes in the put price.

For instance:

If at the current moment the QQQQ stock is traded at $44.56

  • the $45 strike put options are nearest in the money put options and may cost $1.50
  • the $48 strike put options are deep in the money put options and may cost $4.00
  • the $44 strike put options are nearest out the money options and may cost $1.00
  • the $36 strike put options are deep out the money put options and may cost $0.05

Now, if the QQQQ drops by 1% the value of the $44 and $45 strike put options may increase by 20%, the value of the $48 strike put options may increase by 15% and the value of the $36 strike options will most likely remain unchanged. Since the QQQQ options price changes by $0.05 it may require a 5% QQQQ drop to increase the value of $36 strike put options from $0.05 to $0.10 (by 100%) and time is not on the side of the put buyer...

Another parameter that a put options buyer has to define is options expiration. The closer to the expiration the cheaper put options are, however, they are very sensitive to time and they are considered more risky. As a rule 2-3 month expiration options are considered more conservative and the price of these options are not critically affected by the short period of time.

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The Information on the Site is provided for information purposes only. The Information is not intended to be and does not constitute financial advice or any other advice. The trading of stocks, futures, commodities, index futures or any other securities has potential rewards, and it also has potential risks involved. Trading may not be suitable for all users of this Website. Past performance is not necessarily an indication of future performance. You absolutely must make your own decisions before acting on any information obtained from this Website.

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