Welcome to professorsavings.com, we teach finance basics. Today we will teach you about put option basics.
Hi I’m Rayfil Wong. We hope these investment concepts will help you be a better investor.
Professor Savings and Jane both want to buy put options for Orange Computers.
Professor Savings owns 1000 shares of Orange Computers and is going to retire in a year. He wants to protect those shares at the current price of $20.
Professor Savings finds an investor who will sign a contract promising to buy Professor Savings’ shares for $25 in one year’s time.
In return, Professor Savings pays the investor a fee.
If the shares go below $20, Professor Savings will be protected; if the shares go above $20, Professor Savings doesn’t have to use the option, so he only loses the fee paid for the option.
Jane doesn’t own shares in Orange Computers. She pays the same fee for the same option, hoping that the price of Orange Computer drops below $20.
If the stock drops to $10, Jane can buy 1000 shares for $10,000 and sell them for $20,000, a $10,000 profit, minus the fee paid for the option. If not, she’s only out the fee.
Put options allow investors to hedge an investment they don’t own.