As we covered in lecture 2.2, an option has 5 main parameters:
-The underlying asset
–The option type
-The expiry date
-The strike price
-The option price
In section 5 we will be focusing specifically on the put option type. A put option gives the option buyer the right to sell the underlying asset, at the strike price, on the expiry date. Be sure you understand that sentence in its entirety before moving on. It is the buyer of the put option that has the right to sell, meaning it is the buyer of the put option who benefits from the underlying price falling. Some traders who are brand new to options mistakenly believe that because they are betting on the underlying price going down, they must be executing a sell order. With put options this couldn’t be further from the truth, as you need to buy a put option to benefit from a decrease in price. The buyer of the put option is purchasing the right to execute a sell order on the underlying asset at a later date. On the other hand, the seller of a put option makes a loss when the underlying price decreases.
As a put option is the right to sell the asset, we will also look at how buying a put option compares to shorting (selling) the asset itself.
It is a common misconception among traders new to options that a put option is the opposite to being long a call option. This is not the case. As we discussed in previous sections, the opposite to being long a call option is being short a call option. While both being short a call option and being long a put option are both bearish trades, the risk and reward profiles of each are very different, and the rights and obligations are also different.
The buyer of a put option is purchasing the right to sell the underlying asset, at the strike price, on the expiry date. On the other side of the trade, the seller of the put option has an obligation to buy the underlying asset from the buyer, should the put option buyer choose to exercise their right.
In section 5 we will stick to put options in traditional markets, using examples where everything is denominated in US dollars. Then in section 6, we will move on to cryptocurrency put options. This will allow you to first learn the basic mechanics of put options without the added complexity that cryptocurrencies and inverse contracts bring. The differences are particularly important when calculating profit/loss and breakeven points.
So, let’s begin in the next lecture with a simple example of how a company might use a put option.