After last week's issue, my inbox was flooded with some amazing reader questions that I couldn't wait to answer. While some asked about last week's Fossil Group Inc. (Nasdaq: FOSL) trade, most people asked questions about trading strategy basics that I'm more than happy to cover.
I'm always excited to get your feedback and to answer your questions. If you didn't get a chance to ask something before this issue, you can send me a message in the comments below.
Here's what inquiring minds what to know…
You've Got Questions, I've Got Answers
- If a share prices falls, how can I make money from an option? – Mike B.
The easiest, and I think best, way to make money from a stock whose price is declining is simply to buy put options.
When you buy a put option, you are buying the contractual right (options are actually "contracts") to "put" stock onto the person who sold you the put option.
To "put a stock on" someone means you get to sell it to them, like forcing them to buy it from you. If you buy a put whose strike price is $50, $40, $30, whatever the strike is, it means you have the right to sell someone stock at that strike price.
Let's say you think XYZ stock is going down and it's now at $50. Maybe you think it could go down to $30. If you buy a $50 strike price put, that gives you the right to sell someone XYZ at $50, as long as your contract doesn't expire. If the stock drops to $30 and your option hasn't expired, you can put stock on them at $50, meaning you force them to buy stock from you and pay you $50. Then you'd be "short" XYZ, having sold stock you didn't actually own. You can then go into the market and buy the stock at $30 and use that stock to cover (it's done automatically) the stock you are short. By doing that, you made $20 a share.
However, the easier way to make the same $20 (or more) is by simply selling the put option you bought. Whatever you paid for it, it is now worth at least $20, because someone else would want the right to sell XYZ at $50 when it's only trading at $30.
So, you sell the put for at least $20 and profit that way. That's a simple example, but you get the picture.
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Buying put options is a way to profit on betting an underlying stock is going down in price. In contrast, buying call options can bring profit by betting that the stock will go up in price.
To help you remember what a call option is, it gives the buyer the right to "call" the stock to you. Like if you "called" the person who sold you the option to say, "I'm buying it at the strike price you are contracted to sell it to me." And when you buy a call option, you have the right to call stock to you at the strike price.
Hope that helps you remember the difference between different options contracts!
About the Author
Shah Gilani is the Event Trading Specialist for Money Map Press. In Zenith Trading Circle Shah reveals the worst companies in the markets - right from his coveted Bankruptcy Almanac - and how readers can trade them over and over again for huge gains. He also writes our most talked-about publication, Wall Street Insights & Indictments, where he reveals how Wall Street's high-stakes game is really played.