How to Buy Puts in the Stock Market
When people think of making money in the stock market they usually think about buying a stock at one price and selling it for a higher price. But an investor can also make money when a stock goes down in price. This is accomplished by buying a put. A put is an options contract that gives the investor the right but not the obligation to sell the underlying stock for a specified price within a set amount of time. With a put, an investor can bet on the stock declining in value.
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Instructions
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Open a brokerage account with a traditional broker or one of the many online discount brokers. Make sure that the account has privileges to trade in options contracts.
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Understand how put options work. The buyer of a put option contract is purchasing the right to sell 100 shares (each contract represents 100 shares) of a stock at a specified price per share (known as the strike price) within a specified time. The actual price of the contract, on a per-share basis, is usually a fraction of the price of the shares. The buyer of the put option makes a profit on the difference between the lower price he paid and the strike price that he sold it for.
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Consider the following example. An investor buys a contract for $1 a share, or a total of $100 (100 shares in the contract multiplied by $1) in Acme Company. In this example the stock is currently selling at $12 a share, and the strike price is $10 a share. So the contract gives the investor the right but not the obligation to sell the stock at $10. If the price drops below the strike price, to say $8, then the investor can close his position and sell the contract on the open market and make $2 a share.
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Know when to use buy put options. The best times to use buy put options is when you suspect a stock that has been rising lately is about to turn downward. The investor in a bear market, or what he thinks is a bear market, can profit from those who are willing to bet that stock prices are going up.
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Research the trends in the market and make wise decisions on which stocks to buy put options. Even when the market is generally rising there may be a sector that is not doing well. Some companies in this faltering sector could be good candidates for buying put options. Be very careful because options trading, while providing the potential for great profit, can also lead to huge losses if an investor does not do his homework.
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Tips & Warnings
If you buy a stock and the stock price goes down, you may be unhappy but at least you still own shares that are worth something. But if you bet wrong when trading put options--if the share price never falls to the strike price within the contracted time frame--the options are worthless, and the money you invested is a total loss. So, be aware of the risks.
