Intro To Option Trading – Part 3

by Das Brain

What are put option contracts?

This is going to be a more general description of what put option contracts are. First of all, let’s talk about what is common amongst all option contracts whether they are calls or puts. All option contracts you purchase have a strike price and expiration date.

What is the strike price?

Basically, the strike price is where you think or bet that the stock price of the underlying equity will go to by the expiration date.

What is the expiration date?

This is when the option contract expires, and becomes worthless, and cease to exist.

Here is an example with a put contract. Let’s say I purchase a put option contract for Microsoft. The current price of the actual Microsoft stock is at $28.35, the symbol for the stock is MSFT. The option contract is as follows: MSFT Jan 2008 25.00 Put
The symbol for that option contract is: WMFME.X

So the above means is that I bought an PUT option contract for Microsoft stock with a strike price of $25 expiring in January 2008. A put contract is a contract where you are hedging that the stock price of the underlying stock will be the same or going lower. This means that I am betting that Microsoft stock will be at $25 by January 2008.
The cost (premium) of 1 contract was $0.60, but one thing you have to remember is that 1 option contract gives you the right to sell 100 shares of the actual or underlying MSFT stock, so the actual cost of the contract needs to be multiplied by 100, so you pay your brokers $60 + commissions for that 1 Microsoft contract.

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If the Microsoft stock does go lower then the premium on the contract will go up in value, higher. There is a indirect relationship. So let’s say in June 2007 Microsoft stock hits $24, and your Microsoft put contract goes from $0.60 to $1.50, and you decided to sell the contract at $1.50.

Let’s examine the opening and closing transactions, with a $10 commission.

Bought 1 MSFT Jan 2008 25.00 put @ $0.60 X 100 = $60
Sell 1 MSFT Jan 2008 25.00 put @ $1.50 X 100 = $150

Subtract $10 commission to buy, and $10 commission to sell, which equals $20
So Profit is $150 – $60 = $90 -$20 = $70

Now if I had bought three put contracts instead of one then my profit would have been much higher, like $210. As an exercise you can do the math for 4 contracts bought and 4 contracts sold.

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