Put Options Explained: What to Know to Get Started

W hile long-term stock ownership can lead to long-term profits, put options allow investors to control many shares without putting up the cash necessary. They can also help hedge or protect investments.

Investors buy put options if they expect the price of the underlying asset to fall within a specific time frame. Put options are typically good for 100 shares per contract. They’re bought and sold on underlying assets like stocks, bonds, commodities, currencies, futures, exchange-traded funds (ETFs), and indices.

Key Takeaways

  • Put option trading gives an investor the right to sell or short-sell securities at a set price and time. Holders of put options can profit from a drop in a security’s price.
  • Trading put options is a transaction between a seller or writer and the options buyer. Sellers receive a premium, and buyers receive the right to trade the underlying securities.
  • Alternatives to exercising put options include holding and repurchasing them.
  • There are four different strategies to profit from a bearish outlook on an investment: long put, short put, bear put spread, and protective put.

Put Options Explained

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Put options are contracts where holders can, but aren’t required, to sell or a set number of securities at a preset price and timeline. Put options are geared for underlying assets that investors expect to fall in value within a specific time frame and are bearish in nature. They are considered derivative investments, a type of investment with a value that is based on and moves along with the value of another financial product. This financial product is commonly referred to as the underlying asset.

Put options are available for numerous asset classes like stocks, currencies, bonds, commodities, futures, and indexes. They’re sold at a specified price, also known as the strike price. Put option holders have the ability to exercise the contracts but can decide not to use them.

Prices of put options are affected by fluctuations in the cost of the asset to which they’re connected, the strike price of the option, time decay (decline in value of options as they approach expiration), changes in interest rates, and market volatility.

  • Put options gain value as their underlying assets lose value, as volatility in the underlying asset’s value increases, and as interest rates fall.
  • Put options decrease in value as the underlying asset’s price increases, as volatility in the price of the underlying security declines, as interest rates go up, and as expiration dates loom. Investors can only use European-style options on the expiration date.

Time decay escalates as expiration dates near, as time runs out to see a return from the trade. As an option loses time value, only the intrinsic value is left. Intrinsic value is the difference between the strike price and the security’s current price. When an option holds intrinsic value, it’s said to be in the money (ITM). Options with no intrinsic value are known as out of the money (OTM) or at the money (ATM).

Time value, or extrinsic value, puts a value on the timing. Investors add that value to the intrinsic value. Time value recognizes that stock prices may fluctuate before the option’s expiry. Multiple put options on an asset can be merged to create put spreads.

When exercised, put options give investors a short position of ownership in the underlying security. Investors commonly use put options to hedge against losses or speculate on falling prices.

Investors incorporate put options into their strategy to keep their investments safe through a risk management technique known as a protective put. It ensures that losses in an investment do not fall beyond a set amount, the strike price.

How Do You Trade Put Options?

Deciding on trades for put options requires investors to consider many factors. Research the option contract’s value and potential for being profitable when looking into a trade, as the stock may fall beyond the point of being able to turn a profit.

Investors trade put options through brokerages, and some brokerages specialize in options trading. Choose a broker that matches your investment needs. Options are merely financial instruments. As such, they trade very similarly to stocks and bonds. However, purchasing put options is a bit different since they are a contract to buy the underlying securities instead of buying them outright.

Investors need to be approved by a brokerage based on standards that will categorize them into one out of four or five different classes. Investors can purchase options over-the-counter (OTC), which cuts out brokerages and is a direct purchase.

Options contracts usually control 100 shares and may have quarterly, monthly, or weekly dates of expiration. Time frames vary depending on the contract. Investors focus on the premium and the strike price for the option.

Put option sellers, also known as the option writers, receive the premium, which essentially operates like insurance. Writing print options generates revenue. However, the income is limited to the premium. Put buyers can continue to maximize profit until the underlying asset value goes to zero. Option writers are obligated to honor the strike price should the put option be exercised.

Put option buyers have the right to sell the underlying asset for the strike price within a set time frame. For the right to do this, the buyer pays a premium. If the price falls under the strike price, the option will have a monetary value. This is referred to as intrinsic value. The buyer has the right to sell the option for a profit or exercise the option and sell the shares. Exercising the option allows the buyer to sell above the market value and earn a profit.

Put Option Strategies

Investors use put options to profit from a bearish outlook on a stock or other security. There are four strategies that investors can consider to minimize risk or maximize bearishness in the market: long put, short put, bear put spread, and protective put.

Long put

A long put is one of the most basic put options. The investor predicts the price of the stock or underlying commodity will decline within a certain time period, making this a bearish strategy. If the price drops before the expiration date of the contract, investors can sell their shares above market price and realize a profit.

Long options allow investors to invest in expensive stock without the capital to front the funds for it. Since the option is a contract that gives investors the option to sell shares, losses are capped at the premium price paid if the contract is not exercised.

Short put

A short put is an investment strategy that anticipates the price of the underlying stock to exceed or remain at the strike price, making this a bullish alternative to the long put. Short puts allow an investor to attempt to make money off the premium paid on the underlying investment. Short puts work by selling a put option. Sellers of put options are obligated to sell the underlying investment, which is riskier on individual stocks than indexes or other investments like commodities.

When you engage in a short put, you will want to sell when the market price is over the strike price, making it worthless to the buyer, and you will then profit from the premium.

Bear Put Spread

Long puts tend to be more bearish. A bear put spread is common when the investor is less bearish on a stock. Investors generate a bear put spread by shorting, or selling, a put option in which the current price has exceeded the strike price while simultaneously buying a higher-priced put option that currently has a strike price greater than the market price. The expiration date and amount of shares will be the same for each option.

Unlike short puts, losses are limited to the amount of the spread as the worst-case scenario is the stock close in excess of the strike price. In this situation, both contracts are worthless. Profits are limited, though. Bear put spread investors don’t have to worry about volatility since they simultaneously are long and short on the option. A bear put spread utilizes short put options to fund a long put option and mitigate the risk.

Protective Put

Protective put, or the married put, is a strategy that provides an investor a way to safeguard a long position on a regular stock. Protective puts use the options as indemnification for a regular stock position. To utilize this strategy, for every 100 shares of standard owned stock, you would purchase a put option at a specified strike price.

If a stock price declines below the strike price of the put option, investors will sustain losses on the stock, but they’ll be in the money for their put options, minimizing losses by how much the option is in the money.

Put options vary from high-risk to low-risk mitigation strategies depending on how the contracts are structured. Trading put options allows investors to control many shares of a stock without putting up the cash necessary to buy them. They can also be used to hedge or protect investments when the outlook turns bearish. Put options can be considered a form of insurance. Consider the premium for this insurance, as well as the strike price, when looking into this investment tool.

Author: Jason Bond

Jason taught himself to trade while working as a full-time gym teacher; his trading profits grew eventually allowed him to free himself of over $250,000 in student loans!

Now a multimillionaire and a highly skilled trader and trading coach, Over 30,000 people credit Jason with teaching them how to trade and find profitable trades. Jason specializes in both swing trades and in selling options using spread trades, which balance the risk of selling options. Jason is Co-Founder of RagingBull.com and the RagingBull.com Foundation which donates trading profits to charity. So far the foundation donated over $600,000 to charity.

A Complete Guide to Paper Trades

S ome people want to trade stocks, but they are worried about getting it wrong. This level of caution is somewhat understandable as any investment in live trading means risking one’s money. Other people may be reluctant to begin trading due to general nervousness about whether it will work rather than a fear of losing their investment. Whatever the reason for your hesitancy, paper trading can provide a solution. This article offers a complete guide to paper trading, including tips, pros, and cons.

Key takeaways:

  • Paper trading is a simulated way to practice and gain experience in stock market trading basics.
  • There are a number of differences between paper trades and live trades, but the biggest is that emotions have a huge influence on live trading behavior. On the other hand, emotions have a negligible impact on paper trades.
  • To get the most out of paper trading, you should take thorough notes and analyze past trades. Investors should use the results of paper trading to inform their trading strategies in live markets.

What is Paper Trading?

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A paper trade is a simulated trade that enables beginner investors to test out their buying and selling strategies without risking their own money in the stock market. Using an online market simulator, investors are able to practice trading virtually rather than investing in live markets.

Paper trading originated from a time when aspiring investors practiced by writing down hypothetical trading positions and gains and losses on paper. Nowadays, you don’t need to go to the effort of writing everything down; you can use an online stock market simulator instead.

Paper Trading Pros and Cons

The main benefits of paper trading are as follows:

  • Risk-free: Investors don’t need to risk any money when paper trading.
  • Stress-free: Investors can focus on learning how to execute trades and improving trading strategies without the stressful emotions that come up when real money is on the line.
  • Useful learning tool: Paper trades can provide data-driven insights that help investors improve their knowledge about trading stocks.
  • Develops confidence: A novice investor can develop confidence from understanding how to execute trades and earning gains from positions taken during paper trading.

Paper trading also as some drawbacks:

  • It doesn’t factor in correlation: The movement in individual stocks often correlates with the movements of the broader market. During periods of high correlation, individual positions taken during paper trades may have impacted results far less than the broader market conditions.
  • Real trades have commissions: When trading in live markets, there are various commissions to be taken into account that don’t play a part in paper trades. With commissions, the same stock that you think costs $20 per share in a paper trade might cost $20.50 per share in the live market due to commissions.
  • There’s an emotional disconnect: It’s easy to be emotionally disconnected from decisions made during paper trades because there’s nothing on the line other than arbitrary movements in fake money.

Paper Trading vs. Live Trading

An important point to remember is that everything about a paper trade is simulated, including the emotions one feels when trading. There is no inherent risk to your capital when paper trading, which invariably leads to a certain calmness that is difficult to replicate when money is actually on the line. Furthermore, good results in paper trading can provide a false sense of security — you might not take the same risks in a live trade as you do while paper trading.

In live trades, real money is being invested. When people risk their capital, emotions become a huge factor in any decisions that are made. These emotions can affect behavior in live trading, which increases the gap between how buying and selling happen during a simulated trade versus in live markets. Successful investors have learned to control their emotions while under pressure, but it’s unrealistic to expect this same composure when you first enter live markets.

Another difference to note is the liquidity of paper trades versus live trades. When paper trading, liquidity is not an issue, and you can buy or sell stocks in any desirable volume. In live markets, the desired position size might not be so available.

Aspiring traders should keep in mind that the main goal of paper trading is to learn how to properly execute trades and develop basic trading strategies without risking any money. Establishing a successful trading mindset tends to come with experience from live markets.

Paper Trading Tips

Paper trading offers a great opportunity to learn about stock market basics and is a practical way to understand, prepare, and test various trading strategies. Here are some useful tips to get the most out of a paper trade:

Take Thorough Notes

Gone are the days in which the entire practice of paper trading was done by putting pen to paper and recording everything. However, even though online market simulators make it easier to paper trade, it’s a good idea to take your own notes. The more thorough your notes are, the more you can learn about the different trading decisions you made and whether they worked for you.

Consider writing down why you entered and exited each trade, how many shares you bought and why you chose that amount, whether the trade achieved your desired outcome, and what the risk-reward profile of the trade was. This information can provide you with data to analyze at a later point. Data-driven insights can lead to marked improvements in trading strategies.

Use a Realistic Investment

Most simulated trading platforms allow investors to create accounts with unrealistic investments. It can be understandably tempting to start paper trading with an investment of, say, $1 million, but it’s also entirely unrealistic for most beginner traders. The best way to learn from paper trading is to use an investment amount that you would fund a live trading account with.

A big reason to use a realistic investment is that it puts losses and gains in perspective. Investors using an unrealistic amount of money in their paper trading accounts might not think a decision that results in losing $1,000 is bad. However, when viewed through the lens of losing the same $1,000 on a planned $3,000 investment in live trading, that loss is consequential, and the decisions that led to it warrant further analysis.

Similarly, buying 100 shares priced at $100 per share and selling those shares at $101 per share looks good because it gives an easy $1,000 gain, but when the initial investment portfolio is just $2,000, the gain is much less impressive.

Analyze Results

The mere practice of paper trading can be useful, but it’s arguably the post-trading analysis that gives you the best insights. Taking thorough notes provides lots of data to learn from, but this data can only be learned by going back and looking at trades. Investors need to become adept at spotting patterns that led to gains and factors that led to losses.

By analyzing paper trades in-depth, investors can get actionable takeaways about what they are good at and what positions they tend to lose money from before they risk real money on the live market.

Repeat the Process

I t’s a good idea to repeat the process of paper trading over several iterations, which includes placing realistic trades, taking notes, analyzing results, and finding actionable takeaways. Each new takeaway can be used to inform another round of paper trading. For example, if you see that you tend to lose money on long trades, repeat the process while sticking to short trades, and analyze your results.

Keeping these tips in mind, beginner investors can consider going live when they feel they’ve developed a solid understanding of how to execute trades and which strategies work best for them. If you find that your live trades perform poorly compared to your paper trades, you can always go back to paper trading and continue to improve your trading strategies.

Author: Jason Bond

Jason taught himself to trade while working as a full-time gym teacher; his trading profits grew eventually allowed him to free himself of over $250,000 in student loans!

Now a multimillionaire and a highly skilled trader and trading coach, Over 30,000 people credit Jason with teaching them how to trade and find profitable trades. Jason specializes in both swing trades and in selling options using spread trades, which balance the risk of selling options. Jason is Co-Founder of RagingBull.com and the RagingBull.com Foundation which donates trading profits to charity. So far the foundation donated over $600,000 to charity.

What Is a Bull Put Spread Screener?

Bull put option spreads can provide lucrative opportunities and also limit potential losses for investors who do thorough research. In order to do that thorough research, many investors use screeners. Bull put spread screeners analyze bull put credit spreads, which have long and short put options, called legs. They review bull put spreads based on criteria like potential profits and losses, break-even probability, expiration dates, and strike prices of the first and second legs.

Key Takeaways

  • Options spreads enable investors to profit from stock price moves while limiting the risk of losing money. Bullish spreads allow investors to give up some profit potential in exchange for less risk.
  • Options screeners are free or paid tools that analyze potential profits, risks, leg strike prices, and other data relevant to investment decision-making.
  • Using a screener’s results can help investors focus on investment decision-making rather than researching individual options spreads.

What Are Options Spreads?

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Options spreads are available in puts or calls and have two legs. Both legs must either be puts or calls, with one long and one short. Options spreads are different than trading stocks because spreads limit losses. Investors can profit from small movements or no change in the underlying security’s price. Spreads pose less of a risk, but investors also realize smaller gains.

Bull put credit spreads are investments where investors anticipate the underlying stock or security to go up in value. Classified as short put options, they involve selling a put and buying another put at a lower strike price with matching expirations. Proceeds from this type of trade are the credit or premium received or the difference between the short put and long put. Profits are limited, but so are the risks. Strike value minus the credit are the risks. Profit is gained when the underlying security’s price goes above the higher or sold strike upon expiration.

What Are the Types of Spreads?

Spreads can be vertical, horizontal, or diagonal.

  • Vertical spreads: These spreads have two legs with identical expiration dates but different strikes. Generally, the short leg is in the money (ITM), and its proceeds can fund or offset buying the long leg.
  • Horizontal spreads: Also known as calendar spreads, these have two legs with the same strike price but different expiration dates. The short leg has the short term due to time decay. Investors may roll the short leg forward at or near its expiration by selling the next month’s options at an identical strike. Investors may also close the position by selling the longer leg when the short leg expires.
  • Diagonal spreads: Diagonal spreads have two legs with different strike prices and different expirations. They have different purposes, ranging from profiting from time decay or discrepancies in volatility. Diagonal spreads may also be used to roll out other positions, like straddles, or as part of more complex strategies, like butterflies or collars.

How Do Investors Maximize Spread Returns?

Investors can make money on the premium difference between two options contracts. Spread traders may seek to sell the expensive leg of a spread to collect a premium on the time and buy a cheaper leg to limit a potential loss. Time premium correlates to the cost of an option. Time value incorporates implied volatility and other factors.

Trading spreads is more profitable when the time value for the short leg is greater than that of the leg to be purchased. To find the best deal, investors consider time premium and implied volatility of the legs and seek spreads with time premiums greater for the short leg. The short leg will lose value more rapidly than the long leg, increasing the profitability of the transaction.

What Is an Options Screener?

Options screeners are vital tools that analyze potential trades and organize that data in tables that traders can sort and filter. Investors save a lot of research time by using screeners, which helps them focus more on trading decisions, like the best shares and strike prices. Screeners are especially helpful for spreads since there are numerous configurations and possibilities for investments. Investors can customize their searches to meet their needs and yield relevant results.

Options screeners are available from brokerages or other sources online, and investors can choose free or paid screening tools with different features. Paid versions have more features and options for gathering data, saving searches, and generating results, though free screening tools also offer plenty of advantages. Screeners typically seek spreads with higher premiums on the short leg. They don’t usually focus on the probability of a stock going up in price because that characteristic has already been defined if it’s on a bull call report.

Seek spreads where potential gains are higher than the amount of money risked. The spread, which shows the difference between the strike values, is the maximum value the spread will have. Calculate the maximum possible money loss, and if half the transactions create profit, the overall strategy will earn money.

Spread screeners analyze possible combinations for spreads using technical analysis of pricing data. They don’t analyze the underlying stock’s fundamentals or market conditions. Screeners help investors narrow down choices and are one of the many tools and resources that should be used before pursuing an investment.

Screeners detail maximum loss potential, allowing investors to assess the spread’s risk easily. Risk is the difference between the strike price and the sale price of the credit spread. Some put spreads have a downside cushion, which shows how far the underlying stock can fall before the spread loses money.

How Investors Pick Bull Put Spreads

Bull put spreads are usually bullish to neutral. Traders will want to focus on underlying stocks that will go up or remain stable. They seek the investment with the highest chance of success and return on investment (ROI). This requires analyzing data or customized information the screener formats in a table according to individuals’ investment needs and goals.

The bull put spread screener should provide all the relevant information in that table, which the investor can then analyze according to various criteria to find good investment candidates. Evaluation criteria vary from trader to trader but typically focus on potential earnings, risks, and strike prices. Spread screeners allow traders to customize their search results for easy evaluation.

Many traders use maximum loss as a starting point for comparing similar bull put spreads. This information is readily available on screeners and can be the first step in sorting data and customizing searches of spreads.

Once investors decide their maximum loss threshold, they need to use the results to determine whether the maximum gain is worth the risk involved. Risk information and thresholds are readily available for spreads in the screener.

Delta, which is the chance an option will expire in the money, might be a bull put screener criterion depending on the screener used. This number is the probability that the options legs will be in the money by expiration, meaning the chance the options could make or lose money.

Investors usually understand the risk and reward possibilities of bull put spreads but often have trouble deciding on strike prices and how wide to make the spreads. They need to consider expiration dates as well. Screeners provide much of this information, with the next move being interpreting the results and selecting the best investments.

Bull put spreads are versatile investment options that swap profit potential for reduced risk. Bull put spread screeners are a helpful tool for researching potential investments. As with many investment technologies, features vary, and paid versions offer more potential for research and analysis.

Author: Jason Bond

Jason taught himself to trade while working as a full-time gym teacher; his trading profits grew eventually allowed him to free himself of over $250,000 in student loans!

Now a multimillionaire and a highly skilled trader and trading coach, Over 30,000 people credit Jason with teaching them how to trade and find profitable trades. Jason specializes in both swing trades and in selling options using spread trades, which balance the risk of selling options. Jason is Co-Founder of RagingBull.com and the RagingBull.com Foundation which donates trading profits to charity. So far the foundation donated over $600,000 to charity.