hi I'm Jimmy in this video we're looking at how we can use put options to protect
our portfolio or how we can use put options to generate a stream of income
for ourselves a lot like dividends would be the goal here is to understand what
put options are and ultimately how we can use them what the risk is and what
the potential gain is okay so to walk through put options we once again have
our two investors Jimmy who's afraid that people will forget his naming to
keep saying hi I'm Jimmy and the much more confident Emily both have a decent
knowledge of investing which is a good thing because options investing
shouldn't be taken too lightly so Jimmy is interested in buying the put option
and Emily's going to be the seller of the put option now in real life these
two investors would never actually meet and we're never gonna know who's on the
other side of our trade both simply place trades with their brokerage
company and then they move on from there who's on the other side is somewhat
irrelevant I'm just laying these two stories out side by side so we can get
an idea of why they might place their trades and that way we could see what
each investor is risking and what they stand to gain now just like our call
options video we're gonna focus on Verizon stock except this time Jimmy is
the owner of 100 shares of Verizon stock now him owning 100 shares is no
coincidence because one option represents 100 shares
so Jimmy bought the 100 shares so he could deliberately trade options around
that position now that's important for us to remember one option represents 100
shares it doesn't matter what the stock is in our example its Verizon but it
could be any stock that has options trading on but either way it's always
going to be 100 shares okay so Jimmy wants to buy a put option
what does this mean well for me it's easy to understand what a put option is
if we understand what a call option is or at least how the two of them are
related so Jimmy buys a call option well he's
buying the option to buy 100 shares of stock whatever that whatever stock that
particular option is tied to well he can buy 100 shares of that stock at a
predetermined price by a predetermined date they call
the predetermined price the strike price the predetermined date is the expiration
date a put option on the other hand well Jimmy has the option to sell 100 shares
of Verizon stock at the strike price as long as he does it on or before the
expiration date so we might ask well what price can he sell as the shares at
and we know that's known as the strike price what's what is the strike price
going to be who determines that and who determines the expiration date or the
date all of this has to be done by and the answer is Jimmy gets to choose from
whatever the available options are for that particular stock let's look at a
real-life example this is a quote from Verizon's options chain this is what
that looks like and in this particular example this one has an expiration date
of April 17th of 2020 which means that Jimmy has to decide what he's going to
do with the options at a date no later than the close of business on April 17th
okay simple enough now when I pulled down this put option quote it was
January 21st of 2020 so April 17th was 87 days away from that particular quote
and I just want to put that out because the more time you have the more
expensive options will be so for this particular one Verizon stock for this
particular quote Verizon stock at that time was trading at $60 and 31 cents and
this is very important because options are a derivative which means that the
option value is directly tied to the value of the underlying order it derives
its own value from the value of the underlying stock in this case the
underlying is the Verizon stock price so it's important that we know what Verizon
stock price is worth when we're looking at an option but going back to Jimmy's
choices once again maybe 87 days for him is too soon so he wants to pull down
another quote in this case he pulls down June of 2020 now the expiration date for
this particular option is June 19th and by the way monthly options which is
most options that we look at well monthly options they expire on the third
Friday of each month that would explain why put options like this one expire on
the 19th of June or when we looked at the April was
the 17th both in both those cases to the third Friday of the month
okay so Jimmy owns his 100 shares of Verizon stock and he's looking to buy a
put option why would he want to buy a put option well we know that Verizon
stock is currently trading it's slightly more than $60 per share and maybe Jimmy
bought his 100 shares of Verizon stock let's say two years ago and let's
imagine that he paid about $50 per share for these 100 shares so right now he's
up about 10 dollars per share well now the stock is at $60 per share and
Jimmy's looking to sell his stock in the next six months maybe he thinks the
stock is really worth $70 per share so what can he do well he can lock in his
sell price right now if he wants for a fee of course they call that fee a
premium but let's imagine that he decides he's gonna do this so where does
he want to sell his stock that does he want the option to sell his shares $55 a
share well if so that's the option he's looking at by the way each of these
lines are different options they often list them all together in what they call
an options chain they list them all together so you could see them compare
price he can jump from one court to another easy enough but just so we all
know every one of these lines represents a different option so if Jimmy wants the
option to sell his shares for $55 a share he's gonna pay $78 says his that's
his fee though they call that a premium he's gonna pay a premium of $78 for the
option to sell his shares but $55 a share no later than the expiration date
of June 19th now he may notice that this actually says 78 cents not 78 dollars
but like we know options one option represents 100 shares and options are
quoted on a per share basis so 78 cents per share becomes $78 okay simple enough
now you might ask where do they say it's worth 100 shares they don't they
probably won't we just have to know that one option hundred shares move the
decimal point over two spots okay the other thing to note here is that if
we're going to be buying an option generally we're gonna pay the ask price
that's what we get our premium from so you stand down those you'll know how
much have to pay to buy the option if you
were selling it you'd buy the but you'd sell it out the big price just assume
you're always gonna get the worst price if you're gonna buy it you're gonna have
to pay the higher price okay simple enough oh yeah and that's assuming that
we place a market order that's how you end up playing those prices okay
now Jimmy wants the option to sell his shares for fifty seven fifty well he
would pay one hundred thirty-four dollars but let's pretend he decides to
go to the next one down the line he decides that he wants the option to sell
his one hundred shares for $60 per share and don't forget the stock is currently
trading at slightly over $60 per share so technically this put option is out of
the money you might notice the colored area it's slightly blue usually they
color the in the money options in the money defines when the the current stock
price is below the strike price whatever that is that's for put options if it was
a call option it would be the other way around once it again gets above the
strike price those become in the money so for Jimmy this trade makes sense
he pays two hundred twenty four dollars today to lock in a potential sale price
the option to sell the shares for $60 per share so if he's right about Verizon
stock about the fair value and let's say Verizon stock at the end of this option
goes up to 70 or $75 per share well he would simply let that option expire
worthless he would lose the two hundred twenty four dollars that he put up and
then he could decide to sell his shares for 70 or 75 dollars wherever they're
trading at at that point and well maybe he decides to hold on to the shares
that's up to him that's the best part of buying the option is he has the option
he gets the choice and it's his right to decide what to do with it or not but
what if terrible news comes out over the next few months before the June 19th
expiration date and Verizon stock falls back to $50 per share which is where
Jimmy bought his shares or maybe it falls all the way down to $40 per share
or let's go crazy and say some insane news came out and for some reason
Verizon stock falls all the way down to $10 per share well because Jimmy owns
the option because he bought the put option he knows that he can always
exercise that put option which exercise the option means
he will elect to sell his shares for the $60 per share that was in the option
that they agreed to so essentially this option acted as a hedge for Jimmy
they call this a protective put because it protects our position
it caused Jimmy 224 dollars to buy this put option that essentially acts like an
insurance policy for it okay so what about Emily what does she get out of
this and if Jimmy bought the adoption while we know that Emily sold the put
option now let's imagine that Emily sold the very same put option that Jimmy
bought because that will keep the story simple frankly but in truth Emily would
have the very same options that Jimmy had she can choose which time period she
wants to sell which expiration date does she want to use does she want to use it
an expiration date that sooner that in theory would be a less expensive option
or an old a longer-term option that wouldn't there'd be more expensive
either way she gets the choice of which one she wants to sell and at what strike
price she wants to sell it at but for the simplicity of the story we're gonna
say she goes with the same one okay so Jimmy bought the option for 224
dolls let's imagine that she sold the option for the very same price so what
does Emily stand to gain and why would she do this particular trade well her
potential gain her biggest upside her only upside is the $224 she can't make
any more money than that with this particular trade Jimmy's biggest
potential loss when he bought the put option was the 224 dolls and that is
Emily's biggest potential game so why would she do this and what is her
potential loss well Emily thinks that this stock is going higher a lot like
Jimmy thought they both believed that the stock should be worth a lot more
than it is right now well she's very confident in this particular belief so
by selling the put she's able to generate 224 dollars in income for her
portfolio right now and she doesn't even need to be owning the underlying shares
and at Verizon stock on June 19th is trading anywhere above $60 per share
well emily is going to pocket that 224 dolls because the option will
essentially expire worthless the option will disappear after that
is over she gets to keep the 224 dolls and interestingly she doesn't have to
own Verizon shares so she gets to sort of generate this income without putting
up all that much cash no I don't want us to think that Emily could place this
trade if she had no money in her account or very little money in her account
technically this is a margin trade that she's going to place so she needs to
have enough money or enough capital in her account to cover the margin
requirements for this particular trade I believe to sell a put option
broadly speaking Emily would need to have at least 20% of the underlying
stocks value and a few other things you have to have how far in the money in it
or how far out of the money is it you have to have enough to cover the premium
that received in this case it was two hundred twenty four dollars so she would
have to have at least something in her account but her advantage is it's not
like her collateral needs to be cash let's imagine that she has a portfolio
of other stocks or ETFs or maybe it is a little bit of cash in there but let's
imagine the total value of her portfolio is $5000 well that would be enough to
cover the margin requirements for this particular trade so if she has a firm
belief in Verizon stock well perhaps it makes sense to place this type of trade
put the 224 dollars in profit essentially into her account and if
she's right well that's a pretty good percentage return for a $5,000 portfolio
but this is a dangerous part to Emily's position what if Verizon stock falls
maybe falls down to $50 per share or $40 per share or $10 per share
well emily is on the hook to buy those shares at $60 per share because Jimmy
don't forget bought the option to sell them at 60 she has to buy them at 60 and
then she could in theory sell them for 50 or 40 or 10 or wherever the current
stock price is so while yes if she's correct and this and Verizon stock keeps
climbing higher she gets to pocket that 224 but if she's wrong if it ever goes
the other way on her her potential loss in theory is the full $6,000 which is
the $60 per share times 100 shares that would you'd only lose the 6,000 if
and stock went 2-0 sure that's unlikely but imagine the Great Recession happened
it happened faster last December to December's ago happened and the stock
market dropped you know ten percent 15 percent whatever it was in that month if
that was the month her options expired she was in trouble fast because she had
to cover that and knowing she only had a five thousand dollar portfolio well she
might have to put in more capital just to cover that margin call
so the potential loss is the full six thousand dollars the potential gain is
to 224 dollars so I think that the risk reward there it's up to each of us it
depends on our level of confidence our level of experience with this I
personally think if you're gonna sell an option it's better if you pair it with
something else but we'll get into that in future videos different strategies as
to how it can protect yourself a little bit but I do think it's very important
that we understand call options and put options that's gonna be the core of
everything in the options world so if you're not too familiar with call
options I know we just watched a video and put options not too familiar with
call options that could be a good next video to watch there's a link in right
here there's a link in the description below and thank you so much for stick
with me all the way into the video I really appreciate it I'll see in the
next video thanks