This time we address the one of the basic positions in options trading. The sold put. A sale of a PUT contract is an obligation to buy an asset (underlying) on the specified date (maturity) at a fixed price (strike).

When we sell a put, we receive a premium for the purchase of the underlying obligation. If the strike that we do is 6 points; the benefit of the premium is 2 points, our break even is at four points. From this level, we incur in loses on the same proportion as do the underlying. When the underlying at maturity is above the strike, our benefits are fixed and correspond to the price of the premium. As in all cases, there is no actual sale, but a forced sale at a given date.

What do we expect the market where we sell a put?

As all positions sold expect a decrease in volatility and/or in this case… a bull market.

Either of these two facts can be beneficial to this position because, although the market was bearish and volatility is not high, to a lesser extend, we will benefit.

Consider the sensitivity of the option premium to extrinsic factors.

The DELTA in these options is positive, given the increases in the price of the underlying to the position. The more ITM options are, greater intrinsic value, so that the probability of exercise is high damaging the position. As the delta value decreases away from the strike (upward) which favors the put sold.

The GAMMA of a sold put is negative, as we know the gamma of the option indicates the variation of the delta to raise the price of the underlying. As the option is sold, the underlying rise does not affect us to a rise in the price of the option (our greatest benefit is in the premium). So remember that the gamma of the options sold – both puts and calls – is always negative.

The THETA of these options is positive. The passage of time supports the position of options written, the time value decreases as the options approach expiration.

The VEGA showed us the implied volatility of the market if it’s a busy market price variability or if the contrary, is a less aggressive market. Obviously for the options sold, increased volatility hurt positions because we4 have an obligation to fulfill, so the Vega sold the put is negative )as was the case of the sold call)

the RHO also have a negative sign. The Rho is always negative for options to sell (put) because we do not assume that we can take advantage of a payment for interest rates. But this is hardly a factor affecting the price of the premium, and even more the level of rates that we are today.

SELLING A PUT

In this case we bet on the market to be volatile, but lacking on any case with an upward trend. As mentioned above, either of these circumstances is favorable to the seller of put options. Lets peek into the market to take a look at our interest to sell.

Faced with a low volatility on the market we bet for a close expiration, since the risk with an increasing volatility also grow in time.

Every financial market have discounts throughout the year that are not “bargains”. Lets the fun begin.

Lets say you want a stock portfolio with several titles… including Dell stocks for example, because you feel the market will move higher in coming months.

Instead of going to the market and buy directly the stocks, you have decided first to see the range of positions of puts for individual values. For the year-end expiration (4 months let’s say) these are the various strikes. Call now quoting at $11.58 bucks. If we were selling Dell put on strike and maturity 11.50,forcing us to sell at that price; which means below that strike price before the end we will have to buy the stocks… which is what we want after all. The number of stocks we want is 2000 which represents an investment in the spot market of 23160 bucks. If we choose the strike that note,we would get the amount of US$ 0.53*2000 = 1120 dollars; which represents 4.8% of the investment.

You see… if Dell were quoting at maturity below the established $11.50 strike (forcing us to sell) we will have to buy the stock, which was our desire in the first place; but we pocketed a bonus of nearly 5% which is the “rebate”. In the event that at maturity, the price is higher than $11.50 there is no obligation of buying the shares and the put we sold will have no implicit value; would become extinct and we benefit from  the 5% of the premium. In this last case we could start again the operation of “buying with discount” with a new sold put until we buy the stocks that we intent to.

Let’s see what would happen if you actually quoted at $10.50

May occur:

1. Since we had been forced to sell Dell stock to $11.50 (strike), obviously we must buy as the buyer of the put (in a position contrary to ours) will exercise his right on a fairly implied value option. So we bought 2000 shares of which will call the buyer of the option. Our result will be $10.50 – $11.50 * 2000 = – $2000 dollars; Payment of the premium of $1120. Total lost of US $880 equivalent to % 3.82. Meanwhile, the price of Dell shares fallen by 9.33% (from $11.58 to $10.50), which we have benefited from an almost 5%.
2. A more appropriate possibility would be to buy the put option that we had sold the day of maturity, extrinsic value is virtually none and close the position. Our loss would be approximately the same as in the previous case and we could buy the shares or start a new sale of puts. This will be repeated in any asset of the portfolio we want to build.

Around 600 B.C. there was a guy in olg Greece named Thales. Like many others, Thales liked to think about the stuff he saw every day. Olives were a big commodity back in those times; so, for several seasons around that time he wondered why the olives weren’t blossoming, which was sending many citizens and farmers into distress.
Like many other of his contemporaries, He was more of a mathematician than a philosopher, so he studied how olives went from the trees to olive presses and tried to predict when the harvest would come once again.
he was confident that the olives would grow abundantly in the coming year. An astute businessman for his time, Thales cut a deal with many of the farmers, buying the “right” to use their olive presses within a given period of time in exchange for a nominal fee. The farmers, skeptical that the olives would never come again, largely accepted his offer because they figured that getting some profit, no matter how small, was better than getting nothing at all…

Legend says that he never exercised these options and let the farmers slide, partly because he had no time to get involved in the olive business. In any case, this is believed to be one of the very first options trade on record.

The models of evaluation of options were very simple and incomplete until 1973, when Fischer Black, Myron Scholes and Robert C. Merton published the model of evaluation of Black-Scholes-Merton. In 1997 Scholes and Merton got the Nobel Prize of Economy for this work. Sadly, Fischer Black died in 1995 reason by which it was not rewarded but undoubtedly he had been one of the prizewinners.

The model of Black-Scholes-Merton gives a few theoretical values for the Europeans  options put and call on actions who do not pay dividends. The key argument is that the investors could, without covering any risk, compensating long positions with short positions of the action and continuously fitting the ratio of coverage (the value delta) if it was necessary. Assuming that the price of the underlying one continues a chance walk, and using stochastic methods of calculation, the price of the option can be calculated where there are no possibilities of arbitration. This price depends only on five factors: the current price of the underlying one, the price of exercise, the type of interest frees of risk, the time up to the date of exercise and the volatile nature of the underlying one. Finally, the model also was adapted to be capable of valuing options on actions that pay dividends.

The availability of a good estimation of the theoretical value contributed to the explosion of the commerce of options. There have developed other models of evaluation of options for other markets and situations using arguments, assumptions and hardware seemed, as the model of Black for options on futures, the method of Monte Carlo or the model binomial.


Imagine you found a fortune teller who actually is the real deal; and she gave you a hint on Intel inventing the microprocessor…

How much money have you made if you hold a nice chunk of stocks before the iphone invention were made public by apple?

That my dear friend is the power of speculation… and that is where the flexibility of options trading get is root of power. The use of options in this manner is the reason options have the reputation of being risky. This is because when you buy an option; you have to be correct in determining not only the direction of the stock’s movement, but also the magnitude and the timing of this movement.

Investopedia give a good example of how the option concept applies to an everyday situation.

Say, for example, that you discover a house that you’d love to purchase. Unfortunately, you won’t have the cash to buy it for another three months. You talk to the owner and negotiate a deal that gives you an option to buy the house in three months for a price of $200,000. The owner agrees, but for this option, you pay a price of $3,000.

Now, consider two theoretical situations that might arise:

1. it’s discovered that the house is actually the true birthplace of Elvis! As a result, the market value of the house skyrockets to $1 million. Because the owner sold you the option, he is obligated to sell you the house for $200,000. In the end, you stand to make a profit of $797,000 ($1 million – $200,000 – $3,000).

2. While touring the house, you discover not only that the walls are chock-full of asbestos, but also that the ghost of Henry VII haunts the master bedroom; furthermore, a family of super-intelligent rats have built a fortress in the basement. Though you originally thought you had found the house of your dreams, you now consider it worthless. On the upside, because you bought an option, you are under no obligation to go through with the sale. Of course, you still lose the $3,000 price of the option.

This example demonstrates two very important points. First, when you buy an option, you have a right but not an obligation to do something. You can always let the expiration date go by, at which point the option becomes worthless. If this happens, you lose 100% of your investment, which is the money you used to pay for the option. Second, an option is merely a contract that deals with an underlying asset.

Back to our apple example; an option trader made a bet that in 6 months apple stock will be trading 30 bucks above the present time price; but hey… the fortune teller gave you higher expectations; she said the stock were going to be over 100 bucks in increase. Either way, the trading price in 6 months will be higher than the present price; so the options trader buys a call contract.

Assuming that the apple stock of our example is trading at US $50 dollars (the real value price on mid July 2006 give or take), you bought a call contract to buy apple stock at $50 dollars. Well, apple launched the iphone around in early 2007; and by the time your call contract (mid January 2007 following this example), apple stock where selling over $90 bucks.

Since you bought a contract, you have the right to buy the stock, that worth $90 bucks, for $50.

Selling this stock to the open market makes a net profit of US $40 dollars per stock immediately.  The $50 dollar value, stated on the contract is referred as the Exercise or Strike price.

Now; let’s assume that your fortune teller is just like any other… a scam.

If the stock were trading for $20 bucks instead of $90, buying these stocks at $90 dollars is a stupid move. In this situation you can simply choose your right to buy the shares from the open market and let the options expire worthless. Of course you’ll have to pay the contract fees, which are named the Options Premium.

The true power of options lays on their versatility; allowing you to adapt to any upcoming situation. This means you can do everything from protecting a position from a decline to outright betting on the movement of a market or index.

But, as any other financial instrument, options trading involve risk and are not suitable for everyone; especially if you don’t know what you are doing; and because of it, many people will suggest to stay away from options trading.

But been ignorant on the types of investments put you on a weak position against a well versed person.
Perhaps, the speculative nature of options does not fit your investing style… No problem. Do not speculate with options.

My rule of dumb always is; before deciding what position to hold, try to find out and understand everything I can; and I have made enough pennies with options to start building this website around the whole concept of investing in them.

Keep in mind that most options traders have many years of experience, so don’t expect to be an expert immediately after reading this website.