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Put options are the exact opposite of call options. If you are completely clear on your understanding of 'call' options as we discussed in the last section, and through the various educational websites available, then this page will be very straightforward. If you are not 100% clear about 'call' options, it is strongly recommended that you re-read the previous section until you are clear, before your advance further...
A 'put' option allows you the 'right' to sell something at a fixed price for a limited [fixed] period of time.
One of the websites I have mentioned earlier is the cboe.com website. If you go to that website now, move your mouse over the "Quotes" tab at the top, and then select "Delayed Quotes". On the resulting page, under "Delayed Options Quotes", enter the symbol for any stock, eg., "AMZN" [Amazon Inc.] and click "Submit". The resulting page will now show a table for Amazon 'options' which look like this...
On the top-far-right of the table, you can see the price for AMZN stock, which is quoted at $48.06.
You will notice, the table is split into two sides...
The left hand side is for 'Call' options, and the right hand side is for 'Put' options [I have marked this in the red box]. On this page, we are focusing only on 'Put' options, so, simply ignore everything on the left hand side, and focus only on the right hand side of the table, which I have marked in the red box.
You will notice firstly, a series of available 'put' options for Amazon stock. For instance, the one at the top states "05 Dec 45.00". This basically means, if you buy this option, you have the 'right' to sell Amazon stock at $45.00 per share, up until the 'expiry' date, which is quoted as "December 2005". The exact expiry date is the THIRD FRIDAY of the month quoted. The third Friday in Dec'05 is 16th December.
Other 'put' options are also available. For instance, the next one is the "05 Dec 47.50" put option. This basically means, if you buy this option, you have the 'right' to sell Amazon stock at $47.50 per share, up until the 'expiry' date, which, again, is the third Friday of December 2005 [which is 16th December 2005].
Strike Prices & Expiry Dates...
So, we have a very simple table which provides the latest options for different 'strike' prices. The strike price is simply the 'fixed' price you have the 'right' to sell the stock, up until the 'expiry' date. For Amazon stock, the strike prices are fixed at $2.50 intervals, for instance [from the above table] $45.00, $47.50, $50.00, $52.50.
You will also notice there are 'January' expiry options available. These are slightly more expensive to buy, because the expiry date is further out, allowing you more time to maintain the right to sell AMZN at a specific strike- price. The January options expire on the third Friday of January 2006 [which is 20th January 2006].
To recap, a put option provides you with the 'right' to sell a stock at a specific, fixed [or 'strike'] price such as $45.00, up until a fixed 'expiry' date. Let's now look at the options table a little more closely, and study the options 'prices' [or 'premiums']...
I have circled in red above, the 'price' of a put option, which has a 'strike' price of $47.50, and expires on 16th December 2005.
Options Price = Intrinsic Value + Time Value
So, from the above table, the options quote [also known as the option 'premium'] for the "December 47.50" put option is $1.20...
With put-options, note that if the 'strike' price [the price at which you have a right to sell] is ABOVE the actual stock price, then the option will include 'Intrinsic Value' as well as time value. If the 'strike' price is BELOW the actual stock price, then the option will NOT include any intrinsic value, but only [entirely] 'time' value.
The 'intrinsic value' in a put option is the strike price minus the stock price. So, the December 47.50 options have no intrinsic value because the strike price [47.50] is BELOW the actual stock price. Similarly, the December 45.00 options do not have any intrinsic value because, again, the strike price [45.00] is BELOW the stock price.
Now, look at the options where the strike price is ABOVE the stock price. These are the Dec 50.00 options, and the Dec 55.00 options. Remember, the stock price is $48.06, so both these options strike prices [50.00 and 55.00] are ABOVE the stock price. Therefore they contain BOTH intrinsic value AND time value.
The 'intrinsic value' in a put option is the [strike price minus stock price]. So...
Price of Dec 50.00 put options = 2.60
This includes 1.94 intrinsic value + 0.66 time value
Price of Dec 55.00 put options = 7.10
This includes 6.94 intrinsic value + 0.16 time value
Now, let's look at the options where the strike price is BELOW the stock price. These are the Dec 45.00 options, and the Dec 47.50 options. Remember, the stock price is $48.06, so both these options strike prices [45.00 and 47.50] are BELOW the stock price. Therefore they contain ONLY time value...
Price of Dec 45.00 put options = 0.50
This includes ZERO intrinsic value + 0.50 time value
Price of Dec 47.50 put options = 1.20
This includes ZERO intrinsic value + 1.20 time value
Which Put Options Do You Trade?
If you wish to trade 'put' options, follow this simple rule: Whenever the trend index aligns together [as shown in Part 4 of this manual] and you expect a stock to move DOWN, you buy put-options with the strike price NEAREST to the stock price. The strike price can be slightly above or slightly below the stock price, it does not matter, as long as the NEAREST strike price is selected.
Example, if we get a signal for Amazon stock and it is trading at 48.06, then from all of the choices of options in the table above we would choose the strike price nearest to $48.06. As you can see, this is in fact the $47.50 put option.
We also select the 'expiry' month which is closest to the current date, but must have a MINIMUM of 10 trading days before they expire. So, if today's date is 1st December 2005, then the closest options are the December options which expire on 16th December 2005. This provides us at least 10 trading days before they expire. Because the trend index strategy is a short term trading system, we normally expect our stocks to move within 10 trading days, providing ample time to profit in the options.
On the other hand, if there are LESS than 10 trading days left in an option, then we simply select the 'next' months expiry. For example, if today was 9th December 2005, then there are only around 5 trading days left before the December options expire. Therefore, we simply select the 'next' expiry month, and buy those. In this case, we would buy the "January 47.50 Put" options.
A Complete Trading Example...
Imagine it is 25th November, and you have just seen Amazon [MSFT] stock alignment on the trend index charts, expecting it to drop in price. The stock is trading at $48.06.
You go to the CBOE website, and pull up the latest options table for AMZN, focusing on the 'put' options. Now, remember the rules: You look for the option which is NEAREST to the stock price. The nearest option is the 47.50 put option. So, you select this 'strike' price. Also, the closest expiry date is the December option, and there is at least 10 trading days before the December options expire [third Friday = 16th Dec].
So, you select the "December 47.50 Put Options". You check the price, which is quoted at 1.20 cents. That means $120 per contract. You decide to trade 10 contracts, which requires a capital outlay of $1200.
Over the next few days, Amazon stock does indeed fall, and hits $44.05 per share. Remember, you still have the right to sell the shares at $47.50. What is more, you can sell the 'option' itself before it expires. Now, because the stock is currently trading at 44.05, there will be an intrinsic value in the put option of $3.45. Remember, the intrinsic value in a put option is always [strike price minus stock price]. In other words, your put option is now worth AT LEAST $3.45...
In addition, because you are selling your put option BEFORE the expiry date, there is likely to be some 'time value' left in the option. You check the CBOE site again for the latest quote, and indeed the price for the same option is quoting at $3.75. This means that the option has $3.45 intrinsic value PLUS $0.30 time value. You exit your trade.
The result is as follows...
Bought 10 contracts Dec 47.50 Puts @ 1.20 = $1200 Outlay
Sold 10 contracts Dec 47.50 Puts @ 3.75 = $3750 Return
Net Profit On Trade [excluding brokerage fees] = $2550 [or 212% profit]
Typical brokerage fees for the above transaction would have been $15 in, and $15 out, or $30 in total. Discount brokers charge around $1.50 per contract to trade. So, in the above example, trading 10 contracts to buy = $1.50 x 10 = $15. The same again for 'selling' equals a total commission [brokerage fee] of $30.00.
This brings to a conclusion on how 'call' and 'put' options work...
Remember, options are just one way of trading stocks you expect to move up [or down]. It is a good idea to study 'options' trading as much as possible through many books available on the subject. It is often a good idea for stock traders to start off simply trading straightforward [or margined] stocks, which we covered in previous sections of this manual, then experiment a little with options trading, to gain experience before committing oneself wholly to options trading.
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