Description
Put buying is
a strategy used
if the investor
thinks that XYZ
will decline in
price. It is often
used in place of
a short sale in
XYZ stock. The speculative
Put buyer looks
for leverage, emphasizing
the number of options
he or she can purchase.
The "insurance"
Put buyer looks
to protect a long
position in the
stock for a period
of time covered
by the option.
Put Purchase
vs. Short Sale:
Prior to exchange-listed
options, the average
investor only had
one choice if he
or she wanted to
put a bearish opinion
into action - sell
XYZ short. Now,
with Put options,
the investor can
establish a bearish
position while controlling
the trade-offs between
the position's risk
and reward. Along
with the difference
in the profit and
loss profiles, there
are other non-dollar
specific benefits
as well.
Risk/Reward
Characteristics
Break-even
Point: At expiration,
the break-even point
is equal to the
strike price of
the Put option minus
the Put option's
premium. Before
expiration, the
break-even point
is higher.
Profit:
Profits are unlimited
as long as the underlying
stock continues
to decline.
Loss:
Losses are limited
to the premium paid
for the option.
Time Decay:
Negative. A Put
option's premium
consists of both
intrinsic value
(if any) plus time
value. As time passes,
the time value portion
of the Put erodes
(i.e., decays).
At expiration, the
Put's value will
equal its intrinsic
value.
Changes in
implied Volatility:
Changes in the option's
implied volatility
has an effect on
the "time value"
portion of an option's
premium. Thus, a
change in the option's
implied volatility
has the same effect
as changing the
number of days remaining
until the option's
expiration.
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