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What is Put Option and How Does it Work?

Trading operations are conducted with the help of numerous instruments, including different types of procedures and contracts. One of these instruments is known as put options. These are the contracts providing their holders with the right to vent a particular volume of the security in a period and at a price (“strike price”) that are previously determined by the conditions of the agreement. Importantly, this type of option does not generate an obligation to fulfill their conditions but merely a right to do so.

This type of contract can be applied to different underlying assets. Meanwhile, in trading, there is a contrasting concept with rather opposite properties: a call option. This type of obligation provides the owner with the right to acquire a particular asset at the conditions and within the timeframe specified in it.

How do Put Options Work?

Due to their peculiarities, put options are the most valuable when the stock’s price gets smaller. In turn, with the growth of the stock’s price, this contract’s value gets smaller. After a trader utilizes the stock, he or she opens a short position regarding the asset provided by the document. Therefore, among the main purposes for which put options are used, one can distinguish speculating on price movements and hedging.

Put options can also be utilized as devices for managing risks. A person can craft a strategy of acquiring put options to mitigate possible losses from price fluctuations. However, this strategy is only effective if the value of the underlying asset does not get larger than the strike price.

Another factor that plays a significant role in the dynamics of put options’ value is the date when they expire. The closer it gets, the lesser the value of this type of contract. This tendency is perfectly explainable by the fact that the approach of the expiration moment leaves less time for a new holder of an option to implement its provisions and profit from it.

However, in some cases, put options keep on being valuable even after their expiration. Hence, if the strike price of an option is more favorable than that currently prevailing in the market, it is considered to have intrinsic value. Such options are characterized as ITM (“in the money”). If the strike price is lower than that prevailing in the market, the situation is known as OTM (“out of money”). If the two items are identical, the ATM (“at the money”) situation emerges. The last two options are unfavorable for the put option holder.

Brokers’ Role in Option-Related Operations

Alongside most trading contracts, put options are exchanged with the mediation of brokerage agencies. Today, traders have a broad selection of brokerages to deal with. Before selecting an agency that will be best for your trading strategy, you need to conduct a thorough analysis of its activities, as well as benefits and features it can offer you regarding a particular type of assets and contracts you deal with. Alternatively, you can rid yourself of unnecessary hassle and choose one of the recognized leaders in the field of brokerage, such as NSBroker. In any case, remember that selecting the right broker ensures a significant portion of your success in trading.

Ways to Use Put Options

It is not necessary for option writers (which is a conditional term for traders selling put options) to hold these contracts up until they expire. The contract’s premium transforms alongside price fluctuations. As soon as the potential profits that could be obtained from implementing such contracts are suitable for the option holder’s expectations, he or she may vend the contract. The difference between the strike price and the market price would become this person’s actual profits. Meanwhile, if the difference between the strike and market prices starts rapidly decreasing, traders may consider realizing the put options as well to save themselves from potential losses and securing at least some profits.

Bottom Line

Put options are an essential trading instrument utilized to deal with numerous types of underlying assets. They give traders the opportunity to sell assets on terms and within the time specified by the contract. Their value varies depending on the transformation of market prices for assets in respect of which these agreements are concluded. Therefore, in the hands of a professional trader with a well-tuned strategic approach, put options can become an effective tool for making significant profits.

 

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