What Are Put Options And How It Works?
From a third person’s perspective, investing seems to be a fairly simple thing to do with one’s surplus funds. However, it is essential for all prospective investors to realize that investing is rarely ever that easy. For starters, the plethora of choices available to investors in terms of the instruments and the tools for investing in can often seem quite overwhelming. Additionally, even once you have decided on the instruments you wish to trade in, you are constantly required to keep track of movements in the market.
Your understanding of the market should be so good that you are able to preempt as to which economic, political or social developments will cause what kind of impact on the market. While extremely rewarding, maintaining these kinds of efforts is often exhausting. You need to be so well informed about the market that you have no memory of the time that you also wondered what is put options.
What Is Put Options?
Options refer to financial contracts between two parties, wherein the value of the contract is derived from the value of the underlying asset, such as the stocks.
These contracts essentially revolve around the potential future value of the underlying asset. When you buy a put option, you are essentially attaining the right, but not the obligation, to sell a specified amount of the underlying asset at a specified price and on a specified date. This specified price as decided upon through the contract is referred to as the strike price.
The put option is an ideal tool for when the value of the underlying asset falls. When this happens, the value of the asset may fall beneath what the buyer had paid for it. Thus, causing a loss to the buyer. However, in a put option, the contracting parties have already agreed on a strike price. If the market value of the asset falls, the investor stands to make huge profits while selling at the strike rate that was decided well in advance. The investor who bought the put option can also benefit if there is volatility in the prices of the underlying asset or even when the interest rates are lowered.
What Is Call Option?
The call option refers to the right, but not the obligation, to purchase certain stocks at a strike price on a previously agreed upon date.
With a call option, you stand to make a profit if the value of the underlying asset increases before the time period specified for the purpose of the contract. If the value of the underlying asset increases to more than the strike price that was agreed upon, the investor can essentially buy the stock at a significantly lesser amount than market prices.
Read more at How Does Call Options Work?
What Are Advantages Of Put Options?
Since buying a put or call option involves deciding between two very opposing choices, it is important to understand the advantages that each of them brings. If you came here to understand more about the put call option, it is also important to understand how the put option is far more beneficial than a call option. Read on to learn the advantages offered by a put option, that are unavailable with a call option.
1. Favourable Time Decay:
Time is of the essence when you enter into market investments with a long-term goal, and options are a time-bound asset since they expire over a certain specified period of time. The nearer a financial instrument such as an option or a contract is to the completion of its specified time period, the less valuable it becomes. Thus, the option seller or the person with the put option is likely to benefit through the time decay by being able to sell while the option still offers value to them. In this case, however, the person with the call option is not favoured by the time decay.
2. Favourable Stock-Price Direction:
The stock or the underlying asset of an option can move in any direction. It can rise significantly or even drop by an alarming value, on the basis of social, economic and political developments. As an investor with a call option, it becomes necessary to be able to buy the option at a price lower than the strike price for it to be profitable. However, investors with a put option can make profits if the stock price remains unchanged or even if it drops a little. This ensures that a trader with a put option is simply more likely to make profits than a trader with a call option.
3. Favourable Implied Volatility:
While market volatility is a term every trader is familiar with, implied volatility refers to an option’s expensiveness. When the implied volatility in a market is high, the option price tends to be more expensive. As a trader with a put option, you would obviously want to sell when the price is high and buy the assets when the price drops. This is possible when the implied volatility is high, but decreases subsequently. Market observers over the years have noted that high implied volatility has a natural tendency to drop over time, which means that traders with a put option are bound to make profits over a period of time since the natural conditions of the market are in their favour.
Thus, as you can see from the above, buying a put option makes your chances of earning a profit through options significantly higher than buying a call option. Market forces seem like a dominatable force when you first begin investing, but the longer you remain invested, the seeming randomness of the volatility will also begin taking shape. The longer you trade, you will be able to look out for the factors that are likely to impact the market you are trading in, and you will be able to take preemptive measures to safeguard your investments.
Owing to this extensive knowledge that is required before investing into options successfully, it is usually undertaken by long-time traders who are familiar with the market and forces that shape it. Make sure to seek out all the information that you require before you invest a large sum into options trading.