Do you have money invested in the stock market? If you do, I can say with 99% certainty that you are hoping the economy becomes strong and the market goes up, because then your stock investments are likely to go up as well. But, did you know there are people out there that are making money when the stock market is going down? Sounds crazy, right? But it’s absolutely true and can be accomplished by using options.
Call Options and Put Options
Have you ever heard anyone talking about buying on options in regard to the stock market? At the time, you probably didn’t know exactly what they meant, but keep reading and you’ll soon find out! When you buy an option, it means exactly what it sounds like. You’re paying a small amount of money to give yourself the option of either buying or selling the stock at a later date.
The easiest option to understand is the call option. This option allows you pay a small amount of money (compared to the stock price) in order to have the option of paying today’s price at a future date. In other words, let’s say you think a particular stock is going to go up in value in the next month or so (options have varying lengths before they expire). Buy paying a few bucks a share, you now reserved the right to buy the stock at the current price, even though it may skyrocket in value. If the stock price does indeed go up, then you can exercise your option by purchasing the share at the original price and then reselling them at the current market price – netting you an overall profit (a more detailed example will come soon).
A put option is sometimes more difficult to understand, but it’s a great way to make money when the stock value goes down. If you think a particular stock is overvalued and will inevitably go down in the near future, you can buy an option an secure your right to sell at the current stock price. Then, if the stock does go down, you can buy the shares at that reduced stock price and sell them at the high price that you secured when you bought the options.
The Math Behind the Options
Let’s pretend that there’s a company called XYZ. Their stock price is currently valued at $50. You speculate that the stock is currently undervalued and purchase a call option at $3 per share. Typically, you cannot purchase an option for just a single stock. Instead, these options are purchased in lots of 100. So, when you purchase your call option, you’ll initially pay $300 (per share price of $3 times 100 shares). If your speculation turns out to be correct and the stock price rises to $60, you’ve just earned yourself $1,000 minus the $300 you paid for the option, which nets you a total earnings of $700. Not too shabby for a $300 investment.
If, however, the stock did not increase, but rather, stayed the same price or less, then you simply choose not to exercise your option and you lose the $300 that you invested in the first place.
Now, what about a put option? What if you think that $50 stock is going to go down? Let’s say this option current costs $2, so for $200, you purchase the option to sell the 100 shares at the current price of $50 after a designated period of time (let’s just say it’s 30 days). On the 25th day, you take a look at the stock price and sure enough, it plummeted to $35 a share. You decide to exercise your option and buy the 100 shares at the price of $35 and then you quickly sell them at the agreed-upon $50 for your option. You have just made yourself $1,300 on a stock that went down in value ($1,500 minus the $200 option cost).
If the stock went unchanged or went up in value, you earn nothing and are out your $200 that you paid for the option.
There are obviously many other details that you should know before you head out and make options trades, but now you know something that 99% of the population doesn’t. Congrats on learning about call and put options.
Have you ever traded options? Did you know that you could make money in the stock market when it goes down?
My name is Derek, and I have my Bachelors Degree in Finance from Grand Valley State University. After graduation, I was not able to find a job that fully utilized my degree, but I still had a passion for Finance! So, I decided to focus my passion in the stock market. I studied Cash Flows, Balance Sheets, and Income Statements, put some money into the market and saw a good return on my investment. As satisfying as this was, I still felt that something was missing. I have a passion for Finance, but I also have a passion for people. If you have a willingness to learn, I will continue to teach.