Buying Put Options

A put option gives the purchaser the right to sell, go short, a particular commodity contract at a specific price. Put options are purchased to profit from an anticipated price decrease. Opposite the case of call options, the most that a put option buyer can lose is the put option premium plus any transaction costs. The strike price of a put option order is the contract price at which the underlying commodity will be purchased in the event that the option is exercised. The last date on which an option can be exercised is called the expiration date. Options may allow for one of two forms of exercise: American exercise, the option can be exercised at any time up to the expiration date. European exercise, the option can be exercised only on the expiration date.

Example: Expecting a decline in the price of gold, you pay a premium of $1,000 to purchase a June 420 gold put option. The option gives you the right, but not the obligation to sell a 100 ounce gold commodity contract for $420 dollars an ounce. I in fact the June futures price have declined to $390 an ounce. The put option giving you the right to sell at $420 can thus be exercised at a gain of $30 an ounce. On 100 ounces gold contract the sum is equal to a $3,000 gain. Less the put premium, $1,000 paid for the option, your net profit is $2,000. Had you been wrong about the direction or timing of the change in the gold price, the risk is limited to the $1,000 dollar premium paid for the put option plus any transaction costs.

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