How do puts work | Your quick guide to put & call options

New to stock market investing? In this post we take you through the basics from how do puts work to what are calls. Understand strike price, buying & selling puts and more. Let’s get started!

How do put options work?

Investments are inherently risky, and you never know how the market will react. Investors use options to protect their portfolios from losses and they can buy the stock at a lower value than the current market value and increase profit. The two types of options – Put and call options. In this blog, we explain how do put options work.

What is a put option?

We discuss two key concepts, what are put options and what are call options. Put options explained as a contract that gives you the right to sell equity shares at a fixed price called the strike price before a certain date. If you choose or exercise your right to sell your stocks, the writer must purchase the shares from you. Similarly, with call options, the contract holder has the right to buy shares at the strike price before the expiration date.

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What are calls in stocks? 

What are calls in stocks? Call and put options are derivative investments. An investor with options gets the right to buy or sell the financial asset as per the terms of the derivative contract. If you own call stock, you have the right to buy financial instruments at a specific price before the expiration date. Stock in call and puts options are called underlying assets. Traders purchase calls option when they expect the price of the asset to rise.

Call vs put option

An options contract gives investors the right to buy or sell their assets at the strike price on or before a specific date in the future. Call vs put option – call option gives the holder the right to buy a stock, while a put option gives the holder the right to sell a stock. The answer to questions are options are better than stocks is yes options are less risky for the investor and have great leveraging power.

What is a strike price? 

What is a strike price? A strike price is a fixed price at which a derivative contract can be bought or sold. The strike price is also called exercise price, or grant price is a key component for derivatives. The strike price is 

established when the contract is signed and tells the investor the price of the asset before the strike price is invoked. The value of derivatives can be financial contracts like stocks, bonds, indexes, or commodities. 

Options limit risks by hedging, buying time to decide if the stock is worth it.

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How do options work?

You can trade in the future value of the market with options. You pay a premium for the right to trade at a set price before the option expires. How do options work? Stock options are part of the underlying stock, and the price is tied to the movement of the underlying stock. The options premium is affected the buyer’s price and seller’s price.

Two common options are in the money and out of the money. When the strike price is above the market price, it is referred to as – in the money. When the strike price is below the market price, it is referred to as “out of the money.” You need to read the options document carefully to safeguard your interests.

Buying puts

When to comes to answering how do puts work, you also need to know about buying and selling puts.

Buying puts option gives you the right to sell a stock at a price. If you want to buy the puts option, you need to open an account with an options broker. Your broker will assign you a trading level based on your experience, financial resources, and risk tolerance. You need to select a strike price to purchase a put option.

The strike price is usually lower than the current market price. Select the expiration date and decide how many contracts you want to purchase, each option that contains 100 shares of stock. When you purchase a contract, you will have to pay the premium listed and the brokerage fee. You should monitor the stock prices and decide if you should exercise the option. 

Selling Puts

Selling puts options gives you to potentially own the underlying security at both future dates at an agreed-upon price. When you sell put options, you agree to buy a stock at an agreed-upon price is called shorting a put. You lose money if the stock price falls. You buy the stocks at the strike price but sell them at a lower price. You make money when the stock price rises because the buyer is unlikely the exercise the option. The put seller pockets the fee.

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Put option example

To understand how do puts work, let’s take a look at an example. In this put option example, we consider you want to invest in S&P 500 index portfolio, you can purchase the put option. If you are apprehensive about market conditions in the future and are unwilling to lose more than 10% of your position in the S&P 500 fund index.

If the fund is presently trading at $2,500, you can purchase a put option giving you the right to sell the index at $2250 in the next two years. If the market crashes by 20%, you can sell the indexes at $2250 when it is sold at $2000 at a combined loss of 10%.

Most successful options strategy

Traders often try to trade options without understanding the strategies available. Options trading is not a game of luck or chance. Successful trading requires knowledge, practice, and patience. You can learn how to trade options successfully. Here are some of the most successful options strategies.

1. Naked call option

Naked call option strategy involves the investor selling their call option in the open market without owning the underlying security. They can generate a premium without directly selling the underlying security. They take short side call options to deliver shares of the underlying security if the option is exercised before the expiration date. 

2. Married put

Married puts is a strategy where a long investor purchases put options, that usually will have the strike price lower than the current price. The investor who owns the puts and stock is protected against the stock value going below the strike price. It is insurance against the stock decline. 

3. Covered put option

Covered put option is similar to the covered call strategy. Investors sell the put option contract of stock that they have shortened. When an investor sells the put option, they limit their profits by locking the price of the asset and earning a premium from the sale. They use the option when they expect the price to fall.

4. Bull call

A bull call spread has one long call with a lower strike price and one short call with a higher strike price. Both calls have the same stock and expiration date. The strategy behind a bull call is for net debit or costs and profit when the stock prices rise. The profits are limited if the stock price rises. 

5. Long call option

A long call option is when the buyer has the right, not the obligation to buy the stock at the strike price on or before the expiration date. Investors using the long call strategy can buy stocks at a lower price. They purchase the long call option pay the premium or fee for the option itself.

6. Bear put

Bear put spread is a type of options strategy where the investor expects a moderate-to-large decline of the asset and wants to reduce the cost of holding the options trade. Investors purchase put options while selling the same number of puts on the same stock with the same expiration date at a lower strike price.

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7. Short put

Short put is a sale of the put option. A short put is also called a naked put or uncovered put. When a trader sells the put option, they sell the right to sell the underlying stock later and before the expiration date. They hope to earn profits from the premium earned without the risk of the options being exercised. 

Stock options for dummies

Stock options are contract between two parties. To get the best returns from any investment for risks management and trading profits you need to understand trading concepts clearly. You should strategize after understanding risks and rewards. Study the markets for some time before investing. Stock options for dummies explain some simple concepts.

Writing put options

Investors use the puts to generate income or buy stocks at reduced prices. When writing put options, the writer agrees to buy the stocks at the strike price if the contract is exercised. In this case, writing means selling a put contract to open a position. The writer receives a premium for the puts options but will have to purchase the stocks at the strike price.

Buy to open vs buy to close

The difference between buy to open vs buy to close is as follows –

Buy to open means the trader is buying or opening up a pull or a call option. When a trader wants to open an option and pay the premium to secure the position. They have the option of doing something later.

Buy to close means the trader is closing or selling a pull or close option. The trader trades a portion of an existing option to remove themselves from the contract and closes their position and risk. 

In-the-money put 

Investors say a put option is in-the-put when the current market price of the stock is below the strike-out price of the put. They call it in-the-money because the holder has the right to sell the stocks above the market price. The investor will profit if they exercise the in-the-money put option.

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Cash covered put

Cash covered put is a 2-part strategy that involves selling the out-of-money put option while simultaneously setting aside some capital to purchase the underlying stock if it hits the option’s strike price. The investor aims to acquire the stock at a lower price than the market’s offering price if they can buy options.

AMC margin call

A margin call occurs when the value of an investor’s brokerage accounts falls below the broker’s required amount. The margin call indicates that the assets held in the account have decreased in value. When a margin call occurs the investor must add funds to the account or liquidate assets in that account. According to market analysts, the AMC margin call is close.

GME call options

Investors of controversial video game retailer GameStop Corporation (GME) have made bids for the share price before GME declared their earnings. There has been substantial interest in the puts options and nearly double the interest in GME call options. Traders sell call options when they anticipate poor earnings.

High strike trading

The internet has opened up the stock market, it is no longer limited to professional traders. High Strike Trading is one of the largest communities of traders in the world. The school focuses on helping traders make money from the stock market regardless of location or level of experience.

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Stock options FAQ

Stock options give investors the right and not the obligation to buy or sell at a predetermined price and date. The two stock options are – put options and call options. Options are a contract to buy or sell the stocks. In this section, we address some common stock options FAQs.

What does buy to cover mean?

What does buy to cover mean? Buy to cover refers to placing a market order to close a short position, restoring the borrowed shares used for the transaction to the lender. Investors place buy to cover orders with their broker or representatives or give privileges to purchase the shares.

What is an option contract?

What is an option contract? An option contract is an agreement between two parties for a possible transaction. The purpose of an option contract is to buy or sell an underlying asset like a stock, at a predetermined price set when they signed the contract. The transaction can take place till the expiration date of the document. 

What happens when options expire?

You may be wondering what happens when options expire. When options expire they are worthless. Before the expiration date, you have two choices – sell the options to lock in the value, or choose to buy (if the holding is put) or sell (if the holding calls).

What happens if my call option expires in the money?

What happens if my call option expires in the money? An investor will automatically have the stock purchased on their behalf at the strike price. The investor can then sell those shares at the current market price, which is usually higher than the strike price.

What happens when options expire out of the money?

Are you wondering what happens when options expire out of the money? A call option has no value if the security trades below the strike value on or near the expiration date. A put option does not have value when the security trades above the strike value, or near the expiration date. You can always buy the shares (if have call options) sell the shares (puts option) or lock in the value.

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When should you exercise a call option?

When should you exercise a call option? You can exercise a call option in the following circumstances –

• To get dividend – When the time value is less than the dividend payable of the underlying security. 
• At or before the expiration to own the stock- If you are bullish and you may want to exercise the options contract to own the stock.
• To offset a short or long position – you might use options to offset losses from an existing position.

How to exercise a call option?

Exercise is putting into effect the right to sell or buy financial instruments. How to exercise call options? You inform your broker that you wish to exercise the option in your contract. Your broker will initiate an exercise notice, which informs the seller or writer of the contract about your decision to exercise the option. The notice is forwarded to the Options Clearing Corporation (OCC). The seller is obligated to fulfill the terms of the contract.

What makes stock prices go up? 

Do you know, what makes stock prices go up? The stock prices change due to market forces or because of supply and demand. If more people want to purchase shares of a company the prices go up. Share prices are indicative of investor sentiments and expectations about the company. Earnings and profits of the company also affect stock prices. 

How to sell a stock at a certain price?

Now that you have purchased stock, you wonder how to sell a stock at a certain price. You can place a limited order at a certain price. The limit order will not be filled till the price specified by you is reached. However, you can set a limit order below the current market price.

What happens to stock when a company is bought?

What happens to stock when a company is bought? 

Shareholders benefit when a company is bought as the share prices increases. The acquiring company pays more than the current price to encourage traders to sell their shares. When a buyout announcement is made the traders try to purchase the shares increasing the stock value.

When you sell a stock who buys it?

Do you wonder when you sell a stock who buys it? Stock markets match buyers and sellers. When you want to sell your stocks first inform your broker to sell, your order will go into the market as a market order or limit order. The market order does not specify the price at which the stocks will be purchased while the limit price has a set price.

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When does the options market open?

When does the options market open? We can trade stock options are traded during regular stock trading hours, from 9.30 am ET to 4.30 am ET. Most stock options do not have premarket and after-hours because of lower interest. We can trade options based on indexes from 8.00 am to 4.30 pm ET.

How to decide when to sell a stock?

It can be difficult how to decide when to sell a stock? You need to consider several factors before you decide to sell them. Factors to sell a stock are –

• Adjusting your portfolio is a common reason to balance your investment portfolio. Diversifying your portfolio and investing in multiple sectors. 
• If you need money or capital
• If the stock reaches your target price

Selling options for income

Traders need to strategize how to manage their investment while trading in stocks. You can either be bullish (someone who buys a call and sells puts) or bearish (someone who buys puts and sell calls). Take your time to research before selling your options. There are advantages of selling options for income –

• You can have a steady and consistent income stream using options selling. You need to be patient and avoid emotional decisions.
• Remember to use the idea of volatility and complexity to your advantage and examining the price patterns over a period is the best way to determine the performance of the stock. 
• If you sell options at the right time you can transform your portfolio.