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American Put Options. Created by Sal Khan.
Video transcript
Let's say that you dont' like company ABCD that's right now trading for 50 dollars a share but you don't have the stomach to short the stock because there's a possibility that you could lose an infinite amount of money if you short it you still have an option quite literally you still have an option you can buy a put option once again we're dealing with the American variation and just like an American call option an American put option gives you the right to exercise the option any time before the expiration date a European call or put option you can only exercise on the expiration date and the situation with the put option a call option gave you the right to buy the stock at a specified price a put option is the opposite it gives you the right to sell the stock at a specified price so this little made up put option I've constructed right here is maybe being sold on an exchange for five dollars per option and it gives you the right to sell company ABCD at 40 dollars a share any time over the next month and let's see how, if you were to buy this how this really is a bet that the company would go down so let's imagine the scenario where the company does what you expect it goes down and one month later it keeps going down you're like, I better use it today, because it's going to expire if I don't use it today so you exercise the option right over there and so what this allows you to do is sell the stock at 40 dollars and if you don't own it, that's ok, because you can go and buy the stock right now on the market you knew it was going to get cheaper so you can buy it for 20 dollars and then exercise your option and sell it for 40 so you're buying at 20, and immediately selling for 40 so you're gonna be making 20 dollars and then if you subtract out the price that you had to pay for the option you're going to have a 15 dollar profit you're going to have a 15 dollar profit over here let me scroll over to the right so you have some space and this is of course the situation with the put option this is the put option and if your bet goes against you and the stock actually goes up it's not gonna be like a short position where you can lose an unlimited amount of money in that situation let's say the stock just keeps going up and up and up well, any point above 40 dollars, it's like, you know there's no point in me exercising the option so you just let it expire so in that situation you just wasted your money buying the actual option so you just lose the actual 5 dollars even that stock were to go up to a gazillion dollars you're not required to buy it back like you would if you were shorting it you can just let the option expire