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Questions and Answers
What happens when the stock price drops below the strike price of a put option?
Why are options with longer expiration dates more expensive?
What is the main advantage of selling cash secured puts?
What happens if the stock price falls significantly below the strike price in a cash secured put scenario?
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What is the process of executing a cash secured put?
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What happens in Scenario 1 of a cash secured put, where the stock stays above the strike price?
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What is the effective price you pay for the stock in Scenario 2 of a cash secured put, where the stock falls to $4.50 or below?
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What happens if the stock price plummets in a cash secured put scenario?
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Study Notes
Winning and Losing Scenarios
- A winning scenario occurs when the stock price drops below the strike price, allowing the buyer to buy the stock at the lower market price and sell it at the strike price, making a profit.
- A losing scenario occurs when the stock price stays above the strike price, causing the option to expire worthless, and the buyer loses the premium paid.
Effect of Time on Premium
- Options with longer expiration dates are more expensive due to the increased probability of the stock price moving in the buyer's favor.
- More time increases the probability of the stock price moving in the buyer's favor, making longer-term options more expensive.
Cash Secured Puts
- Selling cash secured puts is a strategy to potentially buy stocks at a discount or generate income if the stock does not fall to the desired price.
- Pros: receive premium payment, and if the stock falls to the target price, buy it at a discount.
- Cons: may incur a paper loss if the stock falls significantly below the strike price.
Executing a Cash Secured Put
- Navigate to the options trading section of the brokerage, enter the ticker symbol, select "sell to open", choose the number of contracts, expiration date, strike price, and set the price.
- Example: Sell one Sirius $4.50 put option expiring in 22 days for 32 cents per share, earning $32 in premium.
Scenario Analysis for Cash Secured Puts
- Scenario 1: Stock stays above the strike price, keep the premium and do not buy the stock.
- Scenario 2: Stock falls to the strike price or below, buy the stock at the strike price, effectively at a discounted price with the premium.
- Scenario 3: Stock plummets, buy the stock at the strike price, facing a significant paper loss if the stock falls far below the strike price.
Key Takeaways
- Options trading involves understanding key concepts such as strike prices, premiums, expiration dates, and contract sizes.
- Options trading offers opportunities for significant profit but also carries substantial risk.
- Beginners should practice caution, manage risk, and consider strategies like covered calls and cash secured puts to generate income while mitigating potential losses.
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Description
Learn about the profit and loss scenarios in options trading, including buying put options and exercising them based on stock prices. Understand how time affects premium prices.
