For some investors, it seems counterintuitive that you can make money on a stock that goes down in price. Those folks most likely haven’t heard about options trading or if they have, never pursued it to the point of understanding.
To illustrate my point, I will show you a Put trade, specifically a Buy Put (or long Put) trade on SunEdison (NYSE:SUNE). It was a Money Calendar Sell candidate that turned out well for us. This sort of trade is particularly relevant right now, as world markets post consistent declines.
I also explain this trade in greater detail in my training video below.
First, let’s look at the latest bearish signals for SUNE as depicted in the Money Calendar:
Example: XYZ stock is trading at $40 and you buy a $40 Put option for $2 (this is on a one contract basis, so the cost would be $200 for the option).
Next the stock goes down to $35. You have the right to “Put” or sell the stock to the marketplace at $40 when the stock is at $35. To do that, you would have to buy the stock at $35 and then exercise your right and sell the stock at $40, resulting in a $5 gain. This gain would be offset by the cost of the option price of $2, so you would gain $3 per share.
But we do not buy options to exercise our right on the stock.
When the stock is at $35, it would result in the option being considered “In the Money” or having “Intrinsic Value.” Think of it this way: The stock is at $35 and the $40 Put means it could result in a $5 gain on the stock transaction – it’s a “built in” profit potential of $5.
That $5 will be reflected into the price of the option, because options are comprised of two components that go into their price: Intrinsic Value and Time Value.
If the option you paid $2 for is now at LEAST $5 (not including any time value to make the math/illustration easier), you have a $3 gain on the option trade. Making $3 on a $2 investment is a great return!
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