Options Mini-Class (Four) — Buy Put Pays Money to Buy Insurance for the Position
Previously discussed the Wheel strategy of Sell Put + Sell Call, which is centered around buying at low levels and selling at high levels while continuously collecting premiums in between.
Today we will discuss Buy Put.
To put it simply, Buy Put in a sense means shorting because the most common uses of Buy Put have two purposes: one is to protect an existing spot position from price drops using Put, and the other is to purely speculate on a price decline even if there is no spot position.
Let's use a simple example, assuming the current price of bitcoin:native is $60,000.
I have 1 BTC, but I am worried it might drop below $58,000 in the coming days, and I do not want to sell my BTC now, fearing it might continue to rise. At this time, I can buy a Put.
For instance, I buy a Put that expires on July 10, with a strike price of $58,000, costing a premium of $500.
This Put gives me the right that upon expiration, if BTC drops below $58,000, I can sell my BTC at $58,000.
Please note that I am buying a Put, so I am the one paying. The $500 premium is my cost, and the maximum loss is limited to that $500.
On July 10, at 4 PM Beijing time, there will be two possible outcomes.
Outcome one: BTC is above $58,000.
If BTC rises to $62,000 or remains around $60,000, then this Put is useless. Although I lose the $500 premium, I still hold BTC, and I can continue to benefit from the increase in BTC.
This is like buying insurance; when nothing happens, the premium is wasted. For example, car insurance is like this; everyone buys it when driving, but no one actually hopes to have an accident (not counting insurance fraud).
Outcome two: BTC falls below $58,000.
If BTC drops to $55,000, I still have the right to sell my BTC at $58,000.
At this point, the intrinsic value of this Put is:
58,000 - 55,000 = $3,000
Subtracting the $500 premium I paid before, I actually gain $2,500. Alternatively, I can say I reduced my losses by $2,500.
Since I already held BTC, this $2,500 can offset the loss incurred from the drop in BTC. I am still selling my BTC at $58,000.
In reality, I still incurred a $500 cost, so the real insurance price is:
58,000 - 500 = $57,500
After BTC drops below $57,500, this Put starts to genuinely make me money, or, shall we say, help me lose less. Of course, many times losing less can be viewed as making money because I can still buy back that BTC at $55,000, meaning I still have one Bitcoin and $2,500.
It's still profitable. 😂😂
Of course, if BTC only falls from $60,000 to $58,500, although my judgment about the direction was right and BTC indeed fell, it has not dropped below the strike price, so the Put is still a loss.
In summary, Sell Put is about collecting premiums, with the risk being forced to buy in if the price drops. Buy Put is about paying premiums, with the risk being the premium can be completely lost, but the benefit is the loss limit is known in advance.
Buy Put is like buying a falling opportunity at a fixed cost. For example, spending $500 to buy a Put, I can only lose a maximum of $500 and will not experience a liquidation due to BTC rising.
But the problem is also clear. If I frequently Buy Put and each time the price does not drop, then the premiums will continually consume my principal.
Therefore, Buy Put is more suitable to use when volatility is suspected to increase, or there is a significant risk event in the short term, such as macro data like CPI, Federal Reserve's interest meetings, earnings reports, etc. are the best insurance periods.
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