A put option is the right to sell the underlying future at a certain price.
Buy Put Options
When traders are short of futures contracts, they profit when the market moves lower. The put option has a similar profit potential in the short future if the market goes down.
When prices move downward, the put owner can potentially exercise the option at expiry to sell the future at the original strike price.
This is when the put will have the same profit potential as the underlying future.
However, when prices move up, you are not obligated to sell the future at the strike price which is now lower than the futures price, because that would create an immediate loss.
Protection with a Cost (Premium)
Why would any trader short a future instead of buying a put? The potential to profit on a put option does not come without a cost.
The seller of the option will require compensation for the economic benefit given to the option owner.
This payment is similar to an insurance policy premium and is called the option premium. The buyer of a put option pays a premium to the seller of a put option.
As a result of the added cost of the premium, the profit potential for a put is less than the profit potential of a future by the amount of premium paid.
The price of the future must fall enough to cover the original premium for the trade to be profitable.
The breakeven point for a put is where the profit in the short future that you can sell at the strike price is equal to the premium paid for the put.
Sell Put Options
For every long put option buyer, there is a corresponding put option, “seller”. If you have written a put option, then you receive the premium in return for accepting the risk that you may need to buy a futures contract at a higher price than the current market price for that future.
Put option sellers have risk to the downside. The breakeven point is exactly the same for the put seller as it is for the put buyer.
To review, put options are the right to sell the underlying futures contract. Buyers of the put have protection against adverse price movements. With this protection, they must pay a premium.
Sellers of a put option, collect premium and accept the risk they may need to deliver a futures contract at a strike price.
There you have it. For more information regarding available options, visit Coincall's product pages.