Buying puts can be an effective strategy that may help protect your assets or provide a profit in a bear market. If the price of the stock drops below the strike price of the option, you may be able to sell your contract for more than you paid for it, or, if you own shares of the same stock, you can exercise your put and sell them at the strike price for more than market value. Even if the price rises instead of declining, you can let the option expire and hold onto your shares, losing the premium you paid for the option.
An advantage is that buying puts limits your risk versus selling short. If you sell short, you must borrow shares on margin, which is much more expensive than buying a put. Furthermore, you face unlimited risk when you sell short, as the price of a stock can theoretically rise indefinitely, potentially forcing you to repurchase at a much higher price than the price at which you sold them. The maximum loss you face when you purchase a put, on the other hand, is the amount of the premium.
Long Put Graph
In the graph shown here, the vertical (Y-axis) represents profit and loss, while the horizontal (X-axis) shows the price of the underlying stock. The blue line shows your potential profit or loss given the price of the underlying.
Options involve risk and are not suitable for all investors. Detailed information on our policies and the risks associated with options can be found in Scottrade's Options Application and Agreement, Brokerage Account Agreement, and Characteristics and Risks of Standardized Options (available at your local Scottrade branch office or from the Options Clearing Corporation at 1-888-OPTIONS or by visiting www.888options.com). All option accounts require prior approval by Scottrade. Market volatility, volume, and system availability may impact account access and trade execution. Supporting documentation for any claims will be supplied upon request.