Recently, I posted Part 1 of Options 101, covering call options. I can’t leave my Bears hanging (the market has done enough of that!), so it only feels right that I cover put options next.
Here’s Options 101 – Put Options!
First off, make sure you are familiar with the basics. Check out my first post “Call Option” to get a quick primer (or refresher!) on the topic.
The easiest way to think of a put option is that it is an insurance policy. Imagine you own a house that is worth $1M. You live in California, so you worry about earthquakes. You decide to buy an insurance policy. So you call up your rich friend, Rahul. You offer him a deal.
You will pay him for an insurance policy on the house with $1M of coverage. You’ll pay $50K for the policy, which will expire in December 2025.
Paul accepts. Congratulations, you’ve just purchased a put option!
Strike = $1M
Expiration = December 2025
Premium = $50K
You’re not as worried about an earthquake now. You’re covered!
One of two scenarios now plays out:
- No Earthquake = House (Fine)
- Earthquake = House (Damage)
In scenario 1, you don’t “exercise” your option. The house is fine. You’re only out the $50K premium – worth it for the peace of mind!
In scenario 2, you exercise your option. The house is damaged. Rahul pays you $500K for the damages. You’re happy you bought the insurance.
So to summarize the 101 series…
Call Option = Bullish Bet
Put Option = Bearish Bet
Why buy options?
- Speculate on price movements.
- Hedge long or short exposure.
More to come on the nuances of options – pricing, selling/writing – in Options 102 and 103!
Stay tuned…
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