Buying out of the money put options
Before and after events like this, calls can totally trade richer than puts. Stock crashes and financial crises are pretty rare, but they do happen. Nevertheless, put buyers need to be aware that far OTM puts can trade very rich with implied volatility, yet they have a high likelihood of ultimately expiring worthless. Well, all puts do NOT expire worthless. For far out-of-the-money puts, the likelihood of a worthless expiration is heightened.
Even far OTM puts can double or triple in value with spikes in volatility, and this instills enough fear to cause many put writers to close out their positions; or be obligated to because of margin calls. The margin requirement to buy a put is always the total cost of the premium, i. If you are long an OTM put, you will be fighting premium decay everyday. This is one of the major reasons why making money with puts that are OTM is so difficult.
It depends on your objective. If you bought the put to hedge, then it would obviously be unwise to close the hedge prior to closing the original investment that necessitated a hedge. Ideally, the hedge and the original investment should be closed out at the same time to avoid slippage. A lot of traders who purchase puts out of speculation close out the put prior to expiration. As a general rule, long puts that have decreased to a near zero value should never be closed out.
Essentially, it is a riskless trade. If a long put expires out-of-the-money, there is no need to take action. The position will automatically fall off of your account by the next trading day. If a long put expires in-the-money, there might be some cause for concern. If you do not have enough capital in your account to short the appropriate number of shares, a margin call will likely be issued.
Usually, your broker will contact you prior to expiration asking you to close out a long put position that would have a negative margin impact on your account. The other expiration risk with owning puts, assuming the underlying asset is a stock, is that there will not be a lot of available stock to borrow.
If this is the case, you could end up being short the stock and charged a hard-to-borrow fee. However, this is very rare and it is best to check with your broker prior to expiration about the impact of a long put.
The long put option strategy is a great way to short an asset and eliminate the possibility of an unlimited loss. If you sell a stock or futures contract short, there is always the possibility of the worst-case scenario loss. The long put option trading strategy eliminates this possibility.
If you short a stock or future, the short position itself can never be worthless. This is one of the key distinctions between buying puts and outright shorting an asset. Another key distinction, is that puts are subject to changes in volatility, where shorting an individual asset is not.
Meaning, if an asset crashed, a long put position would benefit from an explosion in volatility as well as, obviously, a decline in the underlying asset. This is one of the reasons why traders like buying puts, because the added component of volatility almost adds another way to make money.
What are Put Options? There are three things to remember that will help you keep these terms straight. At the money options may be a little in or out of the money. They will, however, always be the strike price that is closest to the current stock price. In the video, I will work through each of these differences on a live chain sheet. I will also share a few tips for learning and remembering the differences between these three strike prices.
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