Is Put Trading More Profitable Than Stock Trading?

Posted on August 28, 2010
Filed Under Futures And Options | Leave a Comment

Put trading doesn’t cost as much per share as regular stock trading but can be far riskier if you don’t know what you’re doing. A put option is basically the opposite of a call option. When you trade puts, you’re trading contracts that offer the purchaser the right to sell an amount of stock at a specified price.

If you write a put, you’re betting that the market, or at least the price of that particular stock, will not decrease considerably. If you write a put option that has a strike price below the current price of the stock, you’re hoping the stock will stay above the strike until it expires so that the buyer won’t exercise the option as he will get more money by selling his stock on the open market. You’ll simply make money from the sale of the put.

Even though put trading can be risky, it can also be used as a conservative method to protect from losses. Those who are uncertain if a particular stock will be able to maintain its current price after a large run may purchase puts to protect their gains. If the price of the stock continues to move up, they simply offset the wasted money with the increased profit. If the stock turns around and takes a dive, however, they safely lock in the profit with a guaranteed buyer at the specified price.

When you purchase a put and the stock price drops below the strike price by more than the cost of the put before the expiration date, you will be able to sell the put for a profit. You, as the owner of the contract, may instead choose to exercise it and force the writer to buy your stock for the agreed upon strike price.

Using this information, money can be made from trading puts. You can purchase a put contract, whether you own the stock or not. If a stock is priced at $30, you buy a put option contract with a strike price of $29 for $1, and the stock falls to $25, you would be able to sell your put option contract for about $4. That would mean you just made 300% profit on your investment. Of course, that strategy is risky. If you purchase and continue to hold a put with a strike price below that of the stock’s current price and the stock doesn’t fall by the time the put contract expires, you will lose your entire investment.

Trading in puts and calls doesn’t just occur in the stock market. The foreign exchange market and the commodities market also have options contracts. Business owners who depend on the price of materials and farmers will use puts and calls to protect their profitability. In good seasons, many farmers will have bumper crops. This makes the price of those crops drop since they function on the law of supply and demand. Farmers purchase puts to guarantee a buyer at a specific price. This insures profitability of that season’s harvest. If, when the farmer goes to sell, the price of the crops is lower than the strike price of the put subtracted by the cost of the put, it was a smart move.

No matter what the financial market, if the price rises and falls, there’s sure to be a market for puts and calls. Whether you buy puts to maximize profits, use puts to protect profits, or write puts to make a few extra dollars, put trading can be a useful tool.

Options trading Now has been put trading for some time and is currently holding QQQQ puts and SPY puts.

Comments

Leave a Reply