Put Options Explained

Put Options make you money when the underlying stock price falls. The easiest way to define puts is to compare them to shorting stocks, except the risk is a lot less. So in a nutshell, put options allow you to profit from depreciating stock prices for a fraction of the shorting costs.

The 3 things to know about put options are:

• Break-Even Point - It's simply a fixed price level on the underlying stock, comparable to a watermark in a bucket.
• Strike Price - Like a waterlevel in a bucket, plus also determines the premium paid for the put options contract.
• Movement in Underlying Stock - changes the value of your put options dynamically.

Types of Put Options

There are naked puts, which means you don't own the underlying stock, and covered puts where you actually own the underlying shares. Each type of put option varies in risk based on the quality of the underlying shares, the strike price which the options are held, and the options expiration date.

Put options degrade in value over time as the puts reach expiration, so it's best to buy long put options at least 3 months in advance to avoid quick losses. As the expiration date nears, the value of your put options depreciates fast.

Making Money from Overvalued Stocks with Puts

Put options is how corporate executives and hedge fund managers make so much money when stocks dive in value. They bet big on the puts, in hope that the stock price will fall. You make the most money on puts when the underlying stock is grossly overvalued, allowing you to profit from a selloff.