How to Buy Puts on Stocks
A put (or put option) on stocks is a contract that entitles you to sell a certain number of shares of a stock at a stated "strike" price within a specified time. You may exercise a put on stocks until the option contract expires, but you aren't required to do so. Investors buy puts on stocks for two reasons. One is to protect an investment in the stock itself, which is called the underlying security. Traders also buy puts when they think a stock is likely to decline, in order to make a profit.
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Instructions
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Open a brokerage account that lets you trade options. Options exchanges like the Chicago Board of Options Exchange don't require you to have a margin account (one with borrowing privileges) for basic options transactions. But some brokerage firms do have this rule. To open a brokerage account, you'll need to provide your Social Security number and place of employment, along with personal information. For margin accounts, you must also furnish a statement of your income and assets, and your credit rating will be checked. Expect to pay a minimum initial deposit of $1,000 for regular ("cash") accounts and $2,500 for margin accounts. Online discount brokers may have lower minimum requirements.
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Understand how puts on stocks work. If you buy a put option for 100 shares (a standard contract), you get a guaranteed price. If the stock goes up in price, any shares you have can be sold at the higher market price, so the option has no value. However, if the stock's price drops below the strike price, you can still sell 100 shares of that stock to the option issuer at the strike price. The more the price of the stock falls, the more valuable the put contract becomes.
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Buy puts on stocks to protect an existing investment. Let's say you own 100 shares of XYZ Co. stock that's trading at $73 per share. You don't want to sell the stock, but you don't want to take the chance it will fall in price either. You buy a put contract on the stock with a strike price of $70 per share for the difference between $70 and $73 ($3 per share), plus a $1-per-share premium the option issuer charges, for a total of $4 per share. You've now limited your possible loss to $4 per share. Even if the stock drops to $5 or $10 per share, you can still sell your shares for $70 per share until the option contract expires.
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Trade puts on stocks for profit. Suppose you don't own shares of XYZ Co. but you think the price is likely to drop. You may buy put options even though you don't own any of the stock. Assume the same figures as in Step 3. If the stock declines to $60 per share, you can buy the shares at that price and then sell them for $70 per share. You make $10 per share minus the $40 you paid for the option, for a net profit of $6 per share. On the other hand, if the stock's price goes up, your option contract is of no value and you lose your money.
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Buy put options contracts by phoning your broker or placing the order online (most brokers now offer this option). Tell your broker how many contracts you want, the name of the company, the month the option contract expires and the strike price. For example, you might say, "Buy one put April 70 of XYZ Co." Once you have opened a brokerage account that allows you to trade options contracts, that's all there is to it.
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Tips & Warnings
In the U.S., options may be exercised at any time until they expire. But in Europe many stock options can be exercised only on the expiration date.
