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Put Options are the Red-headed Step Child of Investments

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Put Options

Understanding Put Options

While everyone understands the idea behind a call option, put options operate in an almost counter-intuitive fashion that leaves many investors uneasy. There is no reason to fear them, however. In fact, put options are often a superior choice to their more popular twin, the call option.

How Put Options Work

• In a put option, the option purchaser obtains the ability to sell a block of stock at a fixed price known as the strike. He is not required to sell the stock, but is able to do so if conditions make it desirable for him to do so.

• The desirable conditions the option holder has in mind is for the value of the stock to fall below the price of his put option. This means that he can sell his stock for more than it is actually worth at the moment. If a put option is written to strike at $20 and the share price drops to $10, the option holder gets to sell a stock worth $10 for $20, which results in a nice profit.

• Put options are obviously purchased by investors who expect that the price of the stock is going to drop, and are likewise sold by persons who are counting on the opposite occurring. In this regard, options are something of a bet, in which there is a winning and losing side of the transaction. The net value of the win and loss always adds up to zero.

• Like all other stock options, puts have a maximum life of nine months and are traded American-style, which means they can be activated at any time prior to the expiry of the option.

Put options comprise a valuable, but little understood, tool that can help investors make money in declining markets.

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