How to Trade a Put Option
Options are contracts that trade against the value of an underlying stock. Put options go up in value when the underlying stock goes down. Put options are a way to make a quick profit if a trader predicts a stock or ETF will decline in value. Put trades also have limited risk of loss. The most they can lose is the amount paid for the put contracts.
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Instructions
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Open a stock brokerage account with option trading privileges. To trade options, you must complete extra disclosures with financial and trading experience information. You need at least level 2 option trading privilege to trade put options.
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Select the stock or ETF you believe will decline in value. This the important step in trading a put option and will determine if the trade is profitable. Option traders use stock price charts and technical analysis to help them select positions.
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Enter the stock symbol in your online broker's price look-up field. When the price shows there will be a linkable option near the price called option chain. Click on the option chain link.
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Analyze the stock's option chain for trading candidates. Options are available with several different expiration dates and strike prices above and below the current price of the stock. The further out the expiration date, the higher the option cost, but the greater time for the stock to fall in value and generate a profitable trade. Put options with strike prices above the current stock price are more expensive as they are "in the money." A put option with expiration one to two months out and a strike price near the current stock price is a good choice for a stock that is expected to decline in the next few weeks to month.
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Select or click on the ask price of the chosen put option to be taken to the brokerage option trading screen. To place an option trade you need to have the selected option expiration and price and the number of contracts you want to trade. Selecting the ask price in the option chain screen will take you to the trade screen with the option data populated. You just need to verify the information and enter the number of contracts.
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Place the order to buy the selected put options. The order type will be buy to open. Each contract will cost 100 times the option price plus commission. For example, if the selected put option has an ask price of $3.50, one contract will cost $350 plus commissions. If the bid/ask spread on the option is 10 cents or greater, use a limit order with a price between bid and ask price.
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Monitor the value of the underlying stock and your put option contracts. At the minimum, each contract will gain approximately $100 in value for each $1.00 the underlying stock falls below the put option strike price. Options also have time value, so as expiration approaches, part of the value of your contracts will deteriorate.
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Close out the trade with a sell to close order for the contracts when the underlying stock reaches your target price or the expiration date nears. Option contracts expire on the third Friday of the expiration month.
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Tips & Warnings
As of June 2010, option commissions vary by broker and how active an account is, but many times commissions are the broker's regular stock commission plus 75 cents to $1.50 for each contract traded. Commissions can have a significant impact on an option trader's profit and loss.
Spend some time working with the option chain and option trading screens of you online brokerage account before placing any live trades.
If your broker offers a simulated money, practice account, use that to practice your option trading skills and strategies.
If a put option reaches expiration with the underlying stock price above the strike price of the option contract, the contract will expire worthless. The result will be a 100 percent loss of your investment.
References
- Photo Credit business charts with sell image by Andrew Brown from Fotolia.com
