Financial Markets For The Rest Of Us|
An Easy Guide To Money, Bonds, Futures, Stocks, Options, And Mutual Funds
This table looks awfully familiar. Doesn't it? We saw a similar table for call options except that the symbols are a little different and the premiums are in reverse order, with the FMJ's premium being exactly the same as the FAJ's. Now remember that this is just a sample. Sometimes calls and puts with the same terms and the same positions (e.g., being at the money) have the same premiums, other times they don't. If the momentum of a stock is pointing to a rise, the calls may be more expensive than the puts. But again, it all comes down to supply and demand. If there is more demand for calls than puts, then calls would be more expensive.
Getting back to our example, rather than shorting 200 Ford shares, you could buy 2 FMJ (also referred to as Ford January 50 put) contracts at $2 per underlying share for a total of
200 x $2 = $400 (excluding commission)
Now let's see what you just did. The 2 FAJ contracts give you the right (but not the obligation) to sell 200 shares of Ford stock at $50 per share until their expiration date, let's say 20 days from today. Let's assume that your hunch was correct and Ford's stock declines to $40 per share (from $50) within the 20-day period. Then theoretically you could buy 200 shares of Ford at $40 ($8,000 cost), then exercise your right and sell them for $50 per share ($10,000 total) for a profit of $2,000. And that is the idea about put options. You buy them because you are expecting a decline in the price of the underlying stock by the expiration date. As you have probably guessed, just like call options, you would rarely exercise put options. Instead, if Ford's stock drops to $40 with 10 days to go on the FMJ options, you could probably sell them at $11 per share for the total of
$11 x 200 = $2,200 …
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