These contracts can be used by themselves or they can be invested in with stock positions to act as a hedge.

Single Put Trading

An investor buys 1 SDF Oct 80 Put paying $400. The contract will increase in value (premium), if the market declines. The investor will become profitable if the stock declines below 76 - which is the break-even point on the option. Once the option is profitable, the investor can look at trading options for premium gain or the option can be exercised.

The way the options trader can exercise the put is to purchase the stock at a lower price and then sell the stock at 80 (strike price). As long as that difference is positive, minus the premium, a gain will be achieved.

If the stock declined to 68, the person would have a $1200 gain on the stock - minus the $400 paid, for a total gain of $800. Their would be positive trading results on the Put as well for premium.

The investor is bearish on SDF stock. However, if the market does not decline - the put option could expire worthless. The maximum loss on the long put contract is $400.

Stock with Put Contracts

Put options can also be used as protection positions (long put) or for premium income use (short put).

Long 100 Shares of RTF at $55
Long 1 RTF Dec 50 Put at $200

This trading option position is in place to protect the 100 shares owned. Should the market decline, the investor can exercise the put contract at 50. The maximum loss on the whole position is $700. There is a 5 point stock exposure, plus the $200 premium.

Using put options with stock positions like this allows for protection, similar to a sell stop order. However, if this trading protection turns out not to be needed, the investor has raised his cost on the stock 2 points. The premium paid on the put is true cost. The break even on this contract now and for future trading is 57.

Copyright 2006 American Investment Training, Inc.