Buying Oats Put Options to Profit from a Fall in Oats Prices

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Contents

Buying (Going Long) Oats Futures to Profit from a Rise in Oats Prices

If you are bullish on oats, you can profit from a rise in oats price by taking up a long position in the oats futures market. You can do so by buying (going long) one or more oats futures contracts at a futures exchange.

Example: Long Oats Futures Trade

You decide to go long one near-month CBOT Oats Futures contract at the price of USD 2.0900 per bushel. Since each CBOT Oats Futures contract represents 5000 bushels of oats, the value of the futures contract is USD 10,450. However, instead of paying the full value of the contract, you will only be required to deposit an initial margin of USD 1,350 to open the long futures position.

Assuming that a week later, the price of oats rises and correspondingly, the price of oats futures jumps to USD 2.2990 per bushel. Each contract is now worth USD 11,495. So by selling your futures contract now, you can exit your long position in oats futures with a profit of USD 1,045.

Long Oats Futures Strategy: Buy LOW, Sell HIGH
BUY 5000 bushels of oats at USD 2.0900/bu USD 10,450
SELL 5000 bushels of oats at USD 2.2990/bu USD 11,495
Profit USD 1,045
Investment (Initial Margin) USD 1,350
Return on Investment 77.4074%

Margin Requirements & Leverage

In the examples shown above, although oats prices have moved by only 10%, the ROI generated is 77.4074%. This leverage is made possible by the relatively low margin (approximately 12.9187%) required to control a large amount of oats represented by each contract.

Leverage is a double edged weapon. The above examples only depict positive scenarios whereby the market is favorable towards you. If the market turn against you, you will be required to top up your account to meet the margin requirements in order for your futures position to remain open.

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Writing Puts to Purchase Stocks

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Effect of Dividends on Option Pricing

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Bull Call Spread: An Alternative to the Covered Call

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Leverage using Calls, Not Margin Calls

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Valuing Common Stock using Discounted Cash Flow Analysis

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Oats Options Explained

Oats options are option contracts in which the underlying asset is an oats futures contract.

The holder of an oats option possesses the right (but not the obligation) to assume a long position (in the case of a call option) or a short position (in the case of a put option) in the underlying oats futures at the strike price.

This right will cease to exist when the option expire after market close on expiration date.

Oats Option Exchanges

Oats option contracts are available for trading at Chicago Board of Trade (CBOT).

CBOT Oats option prices are quoted in dollars and cents per bushel and their underlying futures are traded in lots of 5000 bushels (86 metric tons) of oats.

Exchange & Product Name Underlying Contract Size Exercise Style Option Price Quotes
CBOT Oats Options 5000 bu
(Full Contract Specs)
American N.A.

Call and Put Options

Options are divided into two classes – calls and puts. Oats call options are purchased by traders who are bullish about oats prices. Traders who believe that oats prices will fall can buy oats put options instead.

Buying calls or puts is not the only way to trade options. Option selling is a popular strategy used by many professional option traders. More complex option trading strategies, also known as spreads, can also be constructed by simultaneously buying and selling options.

Oats Options vs. Oats Futures

Additional Leverage

Limit Potential Losses

As oats options only grant the right but not the obligation to assume the underlying oats futures position, potential losses are limited to only the premium paid to purchase the option.

Flexibility

Using options alone, or in combination with futures, a wide range of strategies can be implemented to cater to specific risk profile, investment time horizon, cost consideration and outlook on underlying volatility.

Time Decay

Options have a limited lifespan and are subjected to the effects of time decay. The value of a oats option, specifically the time value, gets eroded away as time passes. However, since trading is a zero sum game, time decay can be turned into an ally if one choose to be a seller of options instead of buying them.

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Buying Straddles into Earnings

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Writing Puts to Purchase Stocks

If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount. [Read on. ]

What are Binary Options and How to Trade Them?

Also known as digital options, binary options belong to a special class of exotic options in which the option trader speculate purely on the direction of the underlying within a relatively short period of time. [Read on. ]

Investing in Growth Stocks using LEAPS® options

If you are investing the Peter Lynch style, trying to predict the next multi-bagger, then you would want to find out more about LEAPS® and why I consider them to be a great option for investing in the next Microsoft®. [Read on. ]

Effect of Dividends on Option Pricing

Cash dividends issued by stocks have big impact on their option prices. This is because the underlying stock price is expected to drop by the dividend amount on the ex-dividend date. [Read on. ]

Bull Call Spread: An Alternative to the Covered Call

As an alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement. In place of holding the underlying stock in the covered call strategy, the alternative. [Read on. ]

Dividend Capture using Covered Calls

Some stocks pay generous dividends every quarter. You qualify for the dividend if you are holding on the shares before the ex-dividend date. [Read on. ]

Leverage using Calls, Not Margin Calls

To achieve higher returns in the stock market, besides doing more homework on the companies you wish to buy, it is often necessary to take on higher risk. A most common way to do that is to buy stocks on margin. [Read on. ]

Day Trading using Options

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What is the Put Call Ratio and How to Use It

Learn about the put call ratio, the way it is derived and how it can be used as a contrarian indicator. [Read on. ]

Understanding Put-Call Parity

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Understanding the Greeks

In options trading, you may notice the use of certain greek alphabets like delta or gamma when describing risks associated with various positions. They are known as “the greeks”. [Read on. ]

Valuing Common Stock using Discounted Cash Flow Analysis

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Investing In Oats: What You Should Know About Trading This Commodity

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Last Updated on August 16, 2020

Why Are Oats Valuable?

Oats are a cereal grain with high soluble fiber content. They are a source of food for both humans and animals and an ingredient in the production of cosmetics.

Oats have been growing wild in West Africa since around 12,000 B.C. The first wheat and barley farmers viewed the plant as a weed and a nuisance.

Around 2,000 BC, when wheat farming began in Scandinavia and Poland, farmers observed that oats grew better than wheat in the cold, wet climate of Northern Europe. Nearly 500 years later, farmers in this region began intentionally growing oats. Therefore, oats were one of the last cereal grains to be domesticated.

Today, oat production exceeds 22 million metric tons annually and takes place in diverse countries across the globe. The importance of the crop as both a source of animal feed and a highly nutritious food for humans ensures it will remain a leading global commodity.

How Are Oats Grown?

Oats are a member of the grass family and grow best in cool weather conditions with full sunlight and average, well-drained soil. The crop can tolerate light frosts, but will die when temperatures drop below 5 degrees Fahrenheit.

One of the advantages of growing oats is that the crop does not require intensive maintenance. When planted with other cover crops such as winter peas or winter beans, oats require no additional feeding.

Farmers generally plant oats either in the spring or late summer. Using a broadcast seeding method, they spread the seeds in rows about 3 inches apart.

Oat Plant – Image via Pixabay

The crop goes through several stages of growth before it is ready for harvesting. Oats planted in September will have the following developmental timeline:

Foundation

During the first six months of the plant’s life cycle, three important developments take place:

  1. Root growth – the oat plant produces roots between September and March.
  2. Leaf production – the plant begins leaf production in September and develops its first visible unfolded leaves in November. By December the plant will have developed nine or more unfolded leaves.
  3. Tillering – In December the plant develops its main shoot. By February it develops nine or more tillers.

Construction

The next phase of the crop growth occurs between April and May. Three developments occur:

  1. Stem elongation – The crop’s ears and nodes appear.
  2. Booting – The flag leaf sheaths extend and open.
  3. Ear emergence – The ear emerges above the flag leaf.

Production

Between June and August, the crop completes the final stages before harvesting:

  1. Flowering – the plant begins to flower, which signals the beginning of the harvesting season
  2. Milk development – the grain becomes watery ripe.
  3. Dough stage – the grain accumulates starches and proteins and increases its dry weight
  4. Ripening – the grain hardens and becomes difficult to divide.

Oat harvesting times vary by region. Typically farmers try to time the harvest to occur when the grains have reached 35% moisture – when the green kernels on the plant are beginning to turn a cream color. Harvesting occurs by swathing, or cutting the plants to about 4 inches above the ground. The swathed grains are placed in windows and dried in the sun.

Top 10 Oat Producing Countries

Rank Flag Country Oats Produced (Thousand Metric Tons)
#1 European Union 8,073
#2 Russia 5,440
#3 Canada 3,700
#4 Australia 1,100
#5 United States of America 717
#6 Brazil 682
#7 Chile 670
#8 Argentina 660
#9 Belarus 500
#10 Ukraine 481

Oat millers produce several food products from harvested oats:

Top 7 Oat Products

Product Description
Whole oat groats Oats that had the hulls removed and have been heat treated to inactivate enzymes
Steel cut oat groats Whole oat groats that have been divided into two or four pieces
Whole oat flour Whole oat products that have been ground through hammermills or rollstands
Low bran oat flour Flour produced through bran production that has lower protein and fiber content than whole oat flour
Crushed oats Lightly ground whole groats, steel cut or flakes
Large flake rolled oats Rolled whole oat groats that have been cut into various thicknesses
Quick, baby and instant rolled oats Manufactured by rolling steel cut oat groats

The majority of harvested oats – 95% in the United States are used in animal feed. Yet oats have many health benefits for humans:

  1. High soluble fibers – Oats make you full longer and regulate blood sugar and cholesterol.
  2. Anti-inflammatory properties – Oats have been clinically shown to prevent inflammation and heal dry, itchy skin.
  3. Best amino acid balance of all cereal grains – Oats are used as a water-binding agent in skin care products, shampoos, moisturizers and cleansing bars.

Some food products that use oats include cookies, cereals, bread, muffins, crackers, snacks and even beer.

What Drives the Price of Oats?

The price of oats is generally highly correlated with the price of other grains such as wheat, corn and barley. Most of the economic and trade factors that move oat prices affect agricultural commodities in general. The biggest drivers of prices include:

Supply

The United States Department of Agriculture (USDA) publishes monthly data on global production, consumption, trade and stocks of oats. Traders carefully monitor these numbers for evidence of supply shortages or surpluses.

In recent years, these numbers have been very consistent with only small year-to-year fluctuations in output and consumption.

However, sudden positive or negative surprises could move markets. Traders should monitor the dates of these releases as they can produce volatile trading conditions.

Weather

Weather affects all agricultural crops, and oats are no exception.

If crop yields suffer as a result of a prolonged freeze or an extended drought, then oat prices could spike higher. On the other hand, ideal weather conditions could produce a bumper crop and depress prices.

Drought Conditions Can Severely Impact Oat Production – Image via Pixabay

One factor that somewhat mitigates the role weather plays in oat prices is the global nature of production. Unlike commodities such as coffee or orange juice, where production is heavily concentrated in a small number of countries, oat production is spread out across many regions. Poor growing conditions in one region of the world are sometimes offset by favorable conditions in another area. Nonetheless, weather still has the potential to impact prices.

Price of Corn

Since the primary use of oats is as a feed grain, the price of competing feed grains – especially corn – can impact its price.

If the price of oats rises significantly higher than corn, then farmers might shift toward corn for their feed. Of course, if oat prices are significantly lower than corn, then oat consumption could increase.

Over the last several decades, the price of oats has been highly correlated with corn prices. Many professionals trade the spread between these two commodities by buying the one that’s historically cheap while simultaneously selling the one that’s historically expensive.

Traders looking for clues about oat prices should pay attention to the spread between these two commodities.

3 Reasons You Might Invest in Oats?

Investors purchase agricultural commodities such as oats for many reasons, but the most important ones include:

  1. Inflation Hedge
  2. Bet on Demand Growth
  3. Portfolio Diversification

Inflation Hedge

Investing in oats is a way to bet on higher inflation.

The US Federal Reserve Bank and central banks around the world have kept interest rates low for a long time. These policies are likely to continue since they support consumer borrowing and spending.

Low interest rates have produced speculative bubbles in many assets classes, but not yet in agricultural commodities.

Yet food remains the most basic and fundamental necessity. Food commodity prices could see the largest increases if the economy experiences higher inflation. Oat prices could benefit from these conditions.

Bet on Demand Growth

Oat prices may benefit from strong global economic growth.

The demand for oats in livestock feed could grow as the global population gets wealthier and consumes more meat. As corn and other ‘fuel’ grains get siphoned into biofuel production, farmers will need grains for producing livestock. Oat consumption could benefit from this development.

Oat demand may also benefit from the population seeking healthier foods to consume.

Portfolio Diversification

Most traders have the vast majority of their assets in stocks and bonds. Commodities such as oats provide traders with a way to diversify and reduce the overall risk of their portfolios.

Should I Invest in Oats?

Oats are a cereal grain that compete for demand with the other cereal grains. Consumer preferences for one grain over another largely depend on price. As a result, the prices of many of the cereal grains are highly correlated with one another.

On the other hand, grain prices are often negatively correlated with other agricultural commodities such as livestock.

Therefore, traders wanting to hedge their bets might want to invest in a basket of commodities that includes grains and livestock as well as metals, energy and other commodities.

Investing in a basket of commodities that includes oats and other commodities can mitigate risk and diversify the composition of assets in a portfolio.

A basket of commodities can also provide protection against inflation and protect a trader from the volatility of movements in individual commodities.

Including oats in this basket may make sense for the following reasons:

  1. Emerging Market Growth: China, India and Brazil are among the many fast-growing countries that will have enormous food needs in the years ahead. As these countries increase their meat consumption, their demand for oats may grow.
  2. Climate Change: Global warming is a positive catalyst for oat prices. Lower crop yields from droughts and excessive heat could boost the price of all agricultural commodities including oats.
  3. Health Concerns: Oats are an extremely healthy grain. Demand could benefit as a response to the global obesity epidemic.

However, traders should also consider the risks of investing in oats:

  1. A global economic slowdown could reduce demand for oats.
  2. A sustained drop in the price of other grains could siphon demand away from oats. While, usually, such price drops are temporary, there is no guarantee that this will be the case in the future.
  3. Overproduction of oats could cause prices to slump.

What Do the Experts Think About Oats?

Experts are generally optimistic about oat prices. They cite the drought conditions in the northern plains states as a factor that could limit the supply of wheat. One analyst believes these poor weather conditions should impact oat production as well.

Oats has basically the same growing patterns, same fundamentals as spring wheat. It’s a bullish commodity.

– Brian Hoops, president and senior market analyst at Midwest Market Solutions

How Can I Invest in Oats?

Investors have a limited number of ways to invest in oats:

Oats Trading Methods Compared

Leverage? Regulated Exchange? Oats Futures 5 N N Y N Y Y Oats Options 5 N N Y N Y Y Oats CFDs 3 N N N N Y Y

Oats Futures

The Chicago Mercantile Exchange (CME) offers a contract on oats that settles into 5,000 bushels or about 86 metric tons of oats.

The contract trades globally on the CME Globex electronic trading platform and has expiration months of March, May, July, September and December.

Futures are a derivative instrument through which traders make leveraged bets on commodity prices. If prices decline, traders must deposit additional margin in order to maintain their positions. At expiration, the contracts are physically settled by delivery of oats.

Investing in futures requires a high level of sophistication since factors such as storage costs and interest rates affect pricing.

Oats Options on Futures

Options are also a derivative instrument that employs leverage to invest in commodities. As with futures, options have an expiration date. However, options also have a strike price, which is the price above which the option finishes in the money.

Options buyers pay a price known as a premium to purchase contracts. An options bet succeeds only if the price of oats futures rises above the strike price by an amount greater than the premium paid for the contract. Therefore, options traders must be right about the size and timing of the move in oats futures to profit from their trades.

Oats ETFs

These financial instruments trade as shares on exchanges in the same way that stocks do. There is no ETF that offers pure-play exposure to oat prices. However, several ETFs invest generally in the grains sector:

Oats May ’20 (ZOK20)

Stocks: 15 20 minute delay (Cboe BZX is real-time), ET. Volume reflects consolidated markets. Futures and Forex: 10 or 15 minute delay, CT.

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The Futures Options Quotes page provides a way to view the latest Options using current Intraday prices, or Daily Options using end-of-day prices.

Options prices are delayed at least 15 minutes, per exchange rules, and trade times are listed in CST.

Options Type

American Options: An American option is an option that can be exercised anytime during its life. American options allow option holders to exercise the option at any time prior to, and including its maturity date, thus increasing the value of the option to the holder.

European-Style Options: A European option is an option that can only be exercised at the end of its life, at its maturity. European options tend to sometimes trade at a discount to their comparable American option because American options allow investors more opportunities to exercise the contract.

Short Dated New Crop Options: The term short-dated refers to a shorter window before the option’s last trading day, otherwise known as option expiration. A traditional (or long-dated) option has a longer window before the option expires. In corn, traditional December calls and puts expire in late November. In soybeans, traditional November calls and puts expire in late October. Short-dated options have the same underlying futures contract (or instrument). The underlying futures contract for corn is December, and the underlying futures contract for soybeans is November. With short-dated, there are fewer days of coverage. As an example, a July short-dated option will expire in late June, even though the underlying futures contract is December.

Calendar Spread Options: A calendar spread is an option spread established by simultaneously entering a long and short position on the same underlying asset but with different delivery months. Sometimes referred to as an interdelivery, intramarket, time or horizontal spread.

Weekly Options: Weekly options are the same as standard American Options, except they expire on a Friday.

  • Week 1 options expire on the first Friday of the month
  • Week 2 options expire on the second Friday of the month
  • Week 3 options expire on the third Friday of the month
  • Week 4 options expire on the forth Friday of the month
  • Week 5 options expire on the fifth Friday of the month (if it exists)

Weekly European Options: Same as Weekly Options above but can only be exercised at the maturity date (Friday).

Monday Weekly Options: A weekly option that expires on Monday rather than Friday.

  • Week 1 – 1st Friday of the month
  • Week 2 – 2nd Friday of the month
  • Week 3 – 3rd Friday of the month
  • Week 4 – 4th Friday of the month
  • Week 5 – 5th Friday of the month

Wednesday Weekly Options: A weekly option that expires on Wednesday rather than Friday.

  • Week 1 – 1st Wednesday of the month
  • Week 2 – 2nd Wednesday of the month
  • Week 3 – 3rd Wednesday of the month
  • Week 4 – 4th Wednesday of the month
  • Week 5 – 5th Wednesday of the month

New Crop Options: Options with an expiration date after harvest has been completed.

CSO Consecutive: A calendar Spread where the first leg is the front month and the second leg is the next available month.

Average Price Options: A type of option where the payoff depends on the difference between the strike price and the average price of the underlying asset. If the average price of the underlying asset over a specified time period exceeds the strike price of the average price put, the payoff to the option buyer is zero. Conversely, if the average price of the underlying asset is below the strike price of such a put, the payoff to the option buyer is positive and is the difference between the strike price and the average price. An average price put is considered an exotic option, since the payoff depends on the average price of the underlying over a period of time, as opposed to a straight put, the value of which depends on the price of the underlying asset at any point in time.

Crack Spreads: The spread created in commodity markets by purchasing oil options and offsetting the position by selling gasoline and heating oil options. This investment alignment allows the investor to hedge against risk due to the offsetting nature of the securities.

Crack Spread Average Price Options: Similar to Crack Spreads above, but use Average Price options.

MidCurve Options: Eurodollar Mid-Curve options are short-dated American-style options on long-dated Eurodollar futures. These options, with a time to expiration of three months to one year, have as their underlying instrument Eurodollar futures one, two, three, four or five years out on the yield curve.

Weekly 1-Year Options: Similar to MidCurve options, but expire in 1 weeks.

Weekly 2-Year Options: Similar to MidCurve options, but expire in 2 weeks.

Weekly 3-Year Options: Similar to MidCurve options, but expire in 3 weeks.

EOM Options: End Of Month options are designed to expire on the last business day of each calendar month, offering alignment with month-end accounting cycles.

Additional Selection Criteria

Select an options expiration date from the drop-down list at the top of the table, and select “Near-the-Money” or “Show All’ to view all options.

You can also view options in a Stacked or Side-by-Side view. The View setting determines how Puts and Calls are listed on the quote. For both views, “Near-the-Money” Calls are Puts are highlighted:

  • Near-the-Money – Puts: Strike Price is greater than the Last Price
  • Near-the-Money – Calls: Strike Price is less than the Last Price

Data Shown on the Page

For the selected Options Expiration date, the information listed at the top of the page includes:

  • Options Expiration: The last day on which an option may be exercised, or the date when an option contract ends. Also includes the number of days till options expiration (this number includes weekends and holidays).
  • Price Value of Option Point: The intrinsic dollar value of one option point. To calculate the premium of an option in US Dollars, multiply the current price of the option by the option contract’s point value. (Note: The point value will differ depending on the underlying commodity.)
Stacked View

A Stacked view lists Puts and Calls one on top of the other, sorted by descending Strike Price. Puts are identified with a “P” after the Strike Price, while Calls are identified with a “C” after the Strike Price.

  • Strike: The price at which the contract can be exercised. Strike prices are fixed in the contract. For call options, the strike price is where the shares can be bought (up to the expiration date), while for put options the strike price is the price at which shares can be sold. The difference between the underlying contract’s current market price and the option’s strike price represents the amount of profit per share gained upon the exercise or the sale of the option. This is true for options that are in the money; the maximum amount that can be lost is the premium paid.
  • Open: The open price for the options contract for the day.
  • High: The high price for the options contract for the day.
  • Low: The low price for the options contract for the day.
  • Last: The last traded price for the options contract.
  • Change: Today’s change in price
  • Volume: The total number of option contracts bought and sold for the day, for that particular strike price.
  • Open Interest: Open Interest is the total number of open option contracts that have been traded but not yet liquidated via offsetting trades for that date.
  • Premium: The price of the options contract.
  • Time: The time of the last trade for the options contract.
Side-by-Side View

A Side-by-Side View lists Calls on the left and Puts on the right.

  • Last: The last traded price for the options contract.
  • Volume: The total number of option contracts bought and sold for the day, for that particular strike price.
  • Open Interest: Open Interest is the total number of open option contracts that have been traded but not yet liquidated via offsetting trades for that date.
  • Premium: The price of the options contract.
  • Strike: The price at which the contract can be exercised. Strike prices are fixed in the contract. For call options, the strike price is where the shares can be bought (up to the expiration date), while for put options the strike price is the price at which shares can be sold. The difference between the underlying contract’s current market price and the option’s strike price represents the amount of profit per share gained upon the exercise or the sale of the option. This is true for options that are in the money; the maximum amount that can be lost is the premium paid.
Totals

The totals listed at the bottom of the page are calculated from All calls and puts, and not just Near-the-Money options.

  • Put Premium Total: The total dollar value of all put option premiums.
  • Call Premium Total: The total dollar value of all call option premiums.
  • Put/Call Premium Ratio: Put Premium Total / Call Premium Total
  • Put Open Interest Total: The total open interest of all put options.
  • Call Open Interest Total: The total open interest of all call options.
  • Put/Call Open Interest Ratio: Put Open Interest Total / Call Open Interest Total.

Prices Plunging? Buy a Put!

Investors may buy put options when they are concerned that the stock market will fall. That’s because a put—which grants the right to sell an underlying asset at a fixed price through a predetermined time frame—will typically increase in value when the price of its underlying asset heads southward. Therefore, if you own a put you will benefit from a down market – either as a short speculator or as an investor hedging losses against a long position.

So, whether you own a portfolio of stocks, or you simply want to bet that the market will go down, you can benefit from buying a put option.

Key Takeaways

  • A put option gives the owner the right, but not the obligation, to sell the underlying asset at a specific price through a specific expiration date.
  • A protective put is used to hedge an existing position while a long put is used to speculate on a move lower in prices.
  • The price of a long put will vary depending on the price of the stock, the volatility of the stock, and the time left to expiration.
  • Long puts can be closed out by selling or by exercising the contract, but it rarely makes sense to exercise a contract that has time value remaining.

Prices Plunging? Buy A Put!

Speculative Long Puts vs. Protective Puts

If an investor is buying a put option to speculate on a move lower in the underlying asset, the investor is bearish and wants prices to fall. On the other hand, the protective put is used to hedge an existing stock or a portfolio. When establishing a protective put, the investor wants prices to move higher, but is buying puts as a form of insurance should stocks fall instead. If the market falls, the puts increase in value and offset losses from the portfolio.

Opening a long put position involves “buying to open” a put position. Brokers use this terminology because when buying puts, the investor is either buying to open a position or to close a (short put) position. Opening a position is self-explanatory, and closing a position simply means buying back puts that you had sold to open earlier.

Practical Considerations

Besides buying puts, another common strategy used to profit from falling share prices is to sell stock short. Short sellers borrow the shares from their broker and then sell the shares. If the price falls, the stock is bought back at the lower price and returned to the broker. The profit equals the sale price minus the purchase price.

In some cases, an investor can buy puts on stocks that cannot be found for short sales. Some stocks on the New York Stock Exchange (NYSE) or Nasdaq cannot be shorted because the broker does not have enough shares to lend to people who would like to short them.

Importantly, not all stocks have listed options and so some stocks that are not available for shorting might not have puts either. In some cases, however, puts are useful because you can profit from the downside of a “non-shortable” stock. In addition, puts are inherently less risky than shorting a stock because the most you can lose is the premium you paid for the put, whereas the short seller is exposed to considerable risk as the stock moves higher.

Like all options, put options have premiums whose value will increase with greater volatility. Therefore, buying a put in a choppy or fearful market can be quite expensive – the cost of the downside protection may be higher than is worthwhile. Be sure to consider your costs and benefits before engaging in any trading strategy.

An Example: Puts at Work

Let’s consider stock ABC, which trades for $100 per share. Its one-month puts, which have a $95 strike price, trade for $3. An investor who thinks that the price of ABC shares are too high and due fall within the next month can buy the puts for $3. In such a case, the investor pays $300 ($3 option quote x 100, which is known as the multiplier and represents how many shares one option contract controls) for the put.

The breakeven point of a 95-strike long put (bought for $3) at expiration is $92 per share ($95 strike price minus the $3 premium). At that price, the stock can be bought in the market at $92 and sold through the exercise of the put at $95, for a profit of $3. The $3 covers the cost of the put and the trade is a wash.

Profits grow at prices below $92. If the stock falls to $80, for example, the profit is $15 (95 strike – $80 per share) minus the $3 premium paid for the put. The maximum loss of $3 per contract occurs at prices of $95 or higher because, at that point, the put expires worthless.

The distinction between a put and a call payoffs is important to remember. When dealing with long call options, profits are limitless because a stock can go up in value forever (in theory). However, a payoff for a put is not the same because a stock can only lose 100% of its value. In the case of ABC, the maximum value that the put could reach is $95 because a put at a strike price of $95 would reach its profit peak when ABC shares are worth $0.

Close vs. Exercise

Closing out a long put position on stock involves either selling the put (sell to close) or exercising it. Let us assume that you are long the ABC puts from the previous example, and the current price on the stock is $90, so the puts now trade at $5. In this case, you can sell the puts for a profit of $200 ($500-$300).

Options on stocks can be exercised any time prior to expiration, but some contracts—like many index options—can only be exercised at expiration.

If you wished to exercise the put, you would go to the market and buy shares at $90. You would then sell (or put) the shares for $95 because you have a contract that gives you that right to do so. As before, the profit, in this case, is also $200.

The value of a put option in the market will vary depending on, not just the stock price, but how much time is remaining until expiration. This is known as the options time value. For example, if the stock is at $90 and the ABC 95-strike put trades $5.50, it has $5 of intrinsic value and 50 cents of time value. In this case, it is better to sell the put rather than exercise it because the additional 50 cents in time value is lost if the contract is closed through exercise..

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