Put-ting an End to The Madness Part 1
Editor's Note: Options are a notoriously complex asset class. This post is the first of a series aimed at ending that confusion.
If you search for “explaining put option,” Google serves no less than 3 million potential explanations. With all of the ways to describe a put, how is it then that options are still so hard to understand? The answer: Too many of the hits focus on the mechanics of the put, something that is incredibly complicated, leading to the widespread confusion. While the scenario does require a minimal understanding of mechanics, too few explanations focus on the intent, something much more straightforward.
Understanding The Intent of Put Investing:
Like every other transaction, there is a person buying and a person selling. In the case of buying a put, the buyer purchases the opportunity to sell a stock at a later date for a price and date the two parties agree upon. The seller agrees to buy the stock at the value and date the two have agreed upon. Here’s a quick example using hypothetical company ABC:
|Seller||Agreed Upon Date||Agreed Upon Price of ABC (Per Share)||Number of Shares||Buyer|
|Janice sells this option to Jake for : $1.00|
In the example above, Janice agrees to buy 100 shares of ABC stock from Jake on May 1 for $5.00 per share. Jake will pay Janet $1.00 for this right.
Intent When Selling a Put:
At the most basic level, an investor sells a put when they think a stock might stay above a specific price.*
Janice is confident that ABC shares will stay at $5.00 or rise by May 1, so she’s willing to sell Jake the right to sell her the stock at that price.
Intent When Buying a Put:
An investor buys a put when he or she wants to lock-in a price for a stock just in case that price falls in the future.
Jake wants to make sure that if ABC stock falls, he is still able to keep the $500 value associated with his ownership of the stock, which he is able to do because he purchased the right to do so from Janice.
Putting an End to The Madness
Our hope is that a shift in the conversation towards intent will help to broaden the understanding of these highly useful investments and make them more accessible. The good news is that with StratiFi, the mechanics take a back seat to intent. It’s no different than driving a car. People don’t know how an engine converts gasoline to the energy that propels the car, but they drive nonetheless. Our machine learning based systematic investment process, coupled with our execution technology is no different than a car engine. It does all the grunt work leaving advisors with nothing to do but focus on and assign intent.If you think it might make sense to use options to help preserve your clients’ portfolio, please visit here to schedule a demo.
*An investor might also want to buy a put if the risk associated with the stock falling is less than the proceeds from the sale of the put, but that’s a more complicated scenario that we will tackle in a later post.
To learn more about the truth behind asset correlations and volatility, click here for our complimentary eBook "The Five Myths that Put Portfolios at Risk: Revealing the truth and improving investment outcomes using options."