Buying Put Options

Whereas a call option conveys the right to purchase (go long) a particular futures contract at a specified price, a put option conveys the right to sell (go short) a particular futures contract at a specified price. Put options can be purchased to profit from an anticipated price decrease. As in the case of call options, the most that a put option buyer can lose, if he is wrong about the direction or timing of the price change, is the option premium plus transaction costs.

Example: Expecting a decline in the price of gold, you pay a premium of $1,000 to purchase an April 300 gold put option. The option gives you the right to sell a 100 ounce gold futures contract for $300 an ounce.

Assume that, at expiration, the April futures price has—as you expected— declined to $280 an ounce. The option giving you the right to sell at $300 can thus be sold or exercised at a gain of $20 an ounce. On 100 ounces, that’s $2,000. After subtracting $1,000 paid for the option, your net profit comes to $1,000.

Had you been wrong about the direction or timing of a change in the gold futures price, the most you could have lost would have been the $1,000 premium paid for the option plus transaction costs. However, you could have lost the entire premium.

Reprinted with permission from the National Futures Association. Copyright 2002.