Educational Programming Video
The Value Line Daily Option Survey
Program 3: Buying Puts
This is the third webcast in our series on stock options. In the prior session, we discussed buying call options. This time, we are going to discuss buying put options.
Puts are basically the mirror image of calls. When you buy a call, you pay a premium for the right, but not the obligation, to buy a stock at a certain specified price, known as the strike price, until a specified date, known as the expiration date. When you buy a put, you pay a premium for the right, but not the obligation, to sell a stock at the strike price.
Calls are bullish because you make money if a stock rises. Alternatively, puts are bearish. This is because if a stock falls below the strike price, the value of the put will rise and you will make money. As with calls, puts have only limited risk. This is because even if the stock price rises, the most you can lose is your premium.
The Value Line Daily Options Survey ranks put options from 1 to 5 based on a combination of a common stock's Timeliness rank and the pricing of the put option. If the stock is ranked a 5 (worst)i.e., expected to do worse than most other stocksbut the put is reasonably priced, then the put may well be ranked 1 (best) for put buying. This rank of 1 means that we expect the put buyer to make money when the stock declines. On a typical day, as many as several hundred put options on 100 or more stocks can be ranked 1 for put buying.
Some are of these puts are longer-term options, expiring as much as nine months in the future. Others can be shorter-term, expiring as early as tomorrow.
Some puts can be what we call in-the-money, with the stock price already below the strike price. These offer good profit potential if a stock declines further, but the premiums are usually large. These puts are appropriate for aggressively bearish investors.
Alternatively, some puts have the stock price above the strike price. These are known as out-of-the-money puts. These come at a lower premium, but only gain value if the stock makes a big decline. These puts are appropriate for investors who do not want to commit much capital but want to reap rewards if the stock declines sharply.
Finally, some puts have the stock price equal to the strike price. These puts are known as at-the-money puts. They offer a very good combination of potential profit and protection.
The Value Line Daily Options Survey evaluates all these puts on the basis of their potential rewards versus their risks. All three types, in-the-money, out-of-the-money or at-the-money can be ranked 1 for put buying if the options meet our model's criteria.
Can put buying be profitable? Yes. Very much so. With the market having risen as it has over the past 20 years, our put buying recommendations have fared less well than our call buying recommendations. However, there is ample evidence that some put purchases can help you overall investments. For instance, a small allocation of one's stock portfolio to rank 1 puts can provide much needed profits in down markets. Over the past 20 years, a portfolio consisting of 98% stocks and 2% puts surpassed a stock portfolio without puts by more than 2% per annum by cushioning losses in down markets.
In our next session, we will discuss volatility and how it affects option premiums.