This is the third video in our series on trading options. Be sure to check out our previous videos on this subject to continue your education. Practice these concepts in a demo account: http://bit.ly/trademonster Join us in the discussion on InformedTrades: http://www.informedtrades.com/1265739-example-trading-put-option.html VIDEO NOTES Here are some notes from the video: Example of Selling a Put Option Assume a trader believes SLV will fall in price. A trader could short SLV outright, or they could buy put options. Consider the following scenario: 1. SLV is selling at $18.62 per share 2. A trader buys a put option with a strike price of $18, for a price of $0.33 per share (plus commission). From the previous videos in this series, we know that this means the trader has purchased the right to sell SLV at $18 per share. 3. If the price of SLV falls below $18, the trader can buy SLV and exercise the put option to sell at $18, which in turn will net a profit. For instance, let's say SLV drops to $17 per share. In such a scenario, the following can occur: 1. Trader buys SLV at $17 2. Trader exercises put option to sell at $18 3. $18 - $17 = $1. Minus the price of the option -- $0.33 -- and we see a gross profit of $.67 per share. If we bought options on 100 shares, this would net us a profit of $67, minus any commissions charged by the broker. From this, we can deduce the math of the some of the basics of the reward/risk in this option trade: 1. The option must fall below $17.67 before the option expires to be profitable 2. If the option does not fall below this price before expiration, the trader will not exercise the option. In such a scenario, the loss the trader experiences is at most the cost of the option. If SLV is between $17.67 and $18, the trader can exercise the option to net a small profit -- but one that does not offset the cost of the option. If SLV remains above $18, the trader can simply not exercise the option, and in such a scenario will lost only the cost of the option $0.33 per share. Shorting a Stock vs Buying a Put Option 1. Shorting requires more capital upfront. 2. Shorting has unlimited loss potential while an option has a fixed cost. Even if the trader uses a stop loss order, stops can be run in the event of an overnight market gap. 3. options can yield a greater percentage gain, and thus by extension, require a smaller move in the price of the underlying asset to generate the same return as would be needed if it were just a short trade. 4. Shorting a stock does not have an expiration date, while put options do. In subsequent videos, we'll compare the math for options based on different strike prices (which in turn will have different premiums and different profitability scenarios).
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