Buying Put Options: How to Pick the Right Strike Price ☝

in this video traders we look how buying put options on different strike prices the decision we have to make as traders as to which strike to select hey traders warm welcome to you so you want to buy pop right reminder as a put options a bearish thesis on the stock or commodity whatever is your buying you think that things going to go down you want to buy pops you've decided on your expiry time your timeframe again that's a separate decision to make and we'll go into that some other video but for this video we'll look at how you decide which strike price to choose right so let's look at some examples you've got XYZ stocks currently trading at $50 and you're bearish on this thing you think this is going lower and you think I want to buy pork in just a reminder a put option is the right but not the obligation to sell short or so just sell that stock and you can go show that stock at the strike price at the specified time in future so if you are selling a put option at $50 and that thing goes down to $10 you will exercise that right because it's $40 worth of profit in that option now the other good thing about the poor options guys is this is that the price could go to a thousand and back and if it went to a thousand you are not losing more a van you have paid for the option if between expands your time you took the trade and expiry that thing goes to a thousand you're still only on the hook for the price you pay for those options whereas if you went naked sure you'd be losing every single dollar that thing goes up so that's the advantage of a put option if you have a bare thesis anyway let's go back to the point let's have a look at how we could decide really wash strike we're gonna do so let's look at their three rough examples and you'll see how we can be extending these out in a bit and see what's going on so $50 is the price at the moment and here's our time are on our x-axis here so our 48 50 put is priced at $1 our 50 put is priced at $2 our 50 put it's priced at $3 let's have a look at those so options price generally made up of intrinsic and extrinsic value intrinsic value is the profit in the deal right away so the only one of these examples here has some intrinsic value is this $51 put because this has $1 worth of intrinsic value already right because if this expired now $50 we've got a right to sell shares at $51 it's got $1 worth of intrinsic value okay great so $1 us intrinsic two dollars worth of an extrinsic look at that in a second $50 put right at the money that one's already in there my tax at the buy it's out of the money so at the money $50 put $2 no intrinsic value in fact it's worthless really in terms of if it expired now the right to sell something a 50 which is currently 50 is worth nephal so all that is pure extrinsic value and then we look at the 4850 put of course there's no value that goes below destroy prices out of the money and that has an intrinsic value of 0 but extrinsic value of $1.00 well that's something look closely at this extrinsic value then so extrinsic value is really made up of the time we've got for the for the actual thing to happen time to expiry a strike price and the implied volatility so the further away the time the more potentially like clean is going to happen or more expensive it's going to be the narrower the close to the strike price again the more expensive it's going to because quite likely take that level and the implied volatility its how volatile this thing's expect it to be so I'm going to dig into massively that but that's really how the extrinsic value is calculated but the point of this video is how do we decide on which one to buy let's look at some other extreme example as well so let's imagine now if we look at this one and we go down to here and let's imagine that the the $30 put okay is currently trading out didn't need that there did I come be trading out ah you know 10 cents for example right really kind of unlikely thirty dollars it's only ten cents so we have to make a decision now as traders and this how we make this decision it's gonna affect our profit and loss massively we could lose but be almost right we've got to be pretty right with this so we put the decision to make do we buy a put that's already in the money has some value to it it's the most expensive but it's the most likely of those to make us a profit okay percentage-wise we might not make that much profit but we're gonna could probably make a profit on this if the price just even goes down a little bit we're gonna make money if it goes as a forty seven we're breaking that's that break-even point isn't it because we've paid sorry if the price goes down to 48 that's our break-even point isn't it because we've got three dollars worth of value in that is three dollars so breaking it wasn't 48 but anything below that it's pure pure money okay now $50 put we've gotten we paid $2 for that it's got to be 48 as well and the 4850 put we've got to be at 47 50 for us to make any money however imagine now this stock price went down to $40 in values there's $10 move in the stock what happens to each of these now the $50 put suddenly becomes worth $10 we've made $8 on that deal that pretty good right the 51 put becomes worth $11 and we've made a reasonable amount on that deal as where I eat dollars on that deal but percentage-wise not quite as much because we pay $3 for it the 4850 per however becomes worth $8 50 right because it's 48 52 right to sell stock of 48 50 years of $40 eight dollars 50 we only paid a buck for that so we get a $7 50 profit that's not bad for our $1 investment that's the biggest bang for the buck right that's the biggest return on our investment but of course we've got to have it go much lower than the others the break-even point is much lower than the other ones so now let's look at some extreme examples let's say we he went down to $10 right greater than $10 we could do the mass for that but we don't need to but what I'm interested in is this one this $30 pull if that price goes down to $10 we've got $20 worth of value in the option and we only pay 10 cents of that thing $19.90 worth of profit per option so that is percentage return is huge on what we paid for it yes all these are going to be similarly valued near 48 to 50 50 wonderful is it was similar we go into 10 right you're talking a couple of bucks difference here and there but the percentage return is were the big big difference is from 10 cents to you know massive massive dollar amount and so obviously the chance of it going down to $10 is slim that's why it's priced at 10 cents right it's too far away strike it's got a long time - expiry it's the implied volatility is what it is that's built into one of these but because we've changed the Duda strike price so low the likelihood becomes so low as well that's why it's 10 cents so the point is if you're very very bearish then you might consider something like that or somewhere between these two right so I'm going to be news - I've got extreme here some between these two you might get you know what you know maybe having over the year isn't such a big thing and it's not that badly price because implied volatility is so low I pass perceive it is going to be a spike in volatility if we start to fall off all those kind of stuff so it's figure 2 way up under the commercial rescission future making your trading business do I want to pay a small amount and have a less likelihood of it happening but a bigger payoff or don't want to pay a higher amount have a more likely of occurrence but the payoffs not that big you could you can kind of use the analogy of being a casino right you can go red or black there's a 50/50 shot well it's not a 50/50 shot you get a get a payout you put Center and get 20 out but there's a slight house edge there so the likelihood of you winning is quite high relatively speaking over a period of time but if you go for the one of the numbers or cameraman numbers on a roulette wheel but he's 36 someone can correct me for wrong don't do casinos but if you do that and you get a big payoff rate of 36 times you missed one in 36 36 times your money great but the chances of that happening are slim as well so as a trader the beauty of this is if you believe the chances of it happening are greater than the price then there's your trading edge you can go in and say hey I think that's I think it's going to happen more likely than the price I'm gonna have a go at that and if you're right are more than you're not over a period of time you're gonna make money anyway we'll go into more depth with that but that's just the buying the put options on different strikes the kind of decision you've got to make as a trade if you like this kind of stuff get a thumbs up see you next one take care guys goodbye you

Channel: UKspreadbetting

Views: 111,889

Keywords: put options, buying put options, put options strike prices, how to trade options, put option tutorial, exercise price, stock options basics, how put options work

Id: 8JVziT8mBUI

Length: 9min 52sec (592 seconds)

Published: Wed Aug 22 2018