|
When you buy a “put” you are entering into a contract that gives you the right, but not the obligation, to sell X number of shares of Acme Class A common stock for $Y/share on (or sometimes within) a specific date. So let’s say Acme Class A is currently trading at $50/share. If you think, for whatever reason, Acme Class A common stock will be trading at $1 next week you might want to buy a put that lets you sell 100,000 shares for $10/share. If the price of Acme Class A stays the same, you would never exercise the option to sell because you’d lose money - why would you sell Acme Class A for $10/share when you could sell it on the open market for $50/share? But if you’re right, and Acme Class A is trading at $1/share, you would then of course want to sell as many shares as possible at the $10/share rate. So you’d go on the open market, buy yourself 100,000 shares for $100,000, then turn right around and exercise your option to sell those shares for $1,000,000. So the only money at risk is the cost of the contract itself because you don’t have to actually buy the shares until you decide whether you want to exercise the option to sell them. If you want a put contract that allows you the option to sell 100,000 shares of TSLA for $0.01/share tomorrow it wouldn’t cost much because it’s highly unlikely you’d exercise the option and so, for the person on the other side of the agreement, it would basically be free money. When there’s more uncertainty then the cost of buying the contract is higher because the person on the other side is taking a risk that they’ll be stuck buying a bunch of securities at a price much higher than what they’re actually worth. TLDR: when you buy a put contract you’re essentially paying money to someone to lock in a price. |