Money Rehab with Nicole Lapin - Using Put Options to Avoid Investing Losses

Episode Date: February 5, 2022

In the last two episodes, Nicole has focused on call options. Today, Nicole unpacks put options: the option to sell a share at a certain price. Learn more about your ad-choices at https://www.iheartpodcastnetwork.comSee omnystudio.com/listener for privacy information.

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Well, it doesn't. Charge for wasting our time. I will take a check. Like an old school check. You recognize her from anchoring on CNN, CNBC, and Bloomberg. The only financial expert you don't need a dictionary to understand. Nicole Lappin. Welcome back to our exploration of options.

And I just want to say I hope you've given yourself a nice pat on the back for sticking with me through these bigger, more complicated financial topics. One of my goals with this show, of course, is to empower you with financial literacy so you never smile and nod when Wall Street bros or financial advisors or even friends bring up finance topics you've never heard of. Wrapping your head around the full scope of the money world will help give you agency on your road to financial freedom. Yesterday, we talked about call options, where investors have the option to buy a stock at a certain price. Put options are the options to sell a share at a certain price. That's what we'll

be talking about today. Let's dig into an example and bring back our friend Lily. Let's say Lily owns shares of a company with the ticker L-A-M-E. Currently, the market price is $20 a share. But say Lily has concerns that Lame's price may tank. Maybe Lily knows that the company is undergoing an investigation and the report will be published on March 15th. She's worried that the results of the report may be negative and the stock price will plummet. Whatever the reason, Lily has a sneaking suspicion that the stock price will fall. If she thinks that the current price is the highest value the stock will ever reach, she may want to purchase the option to sell her shares at the current market value. If this isn't quite clicking yet, stay with me because I think it will soon. So Lily logs onto

her brokerage account and pulls up the list of put options. She sees that she can secure the option to sell her LAME stock at $20 a share by March 17th. If Lily buys the put option, a few different scenarios could pan out. Let's look at a situation where she does want to exercise the option and an alternate scenario where she lets the option expire. Scenario number one. And spoiler alert, this means better returns for Lily. On March 17th, Lily wakes up to find that LAME stock is trading at $20 a share. In that scenario, Lily has the option to sell her shares at $25 a share when the market price of the stock is $20 a share.

In other words, she has the opportunity to sell her shares for greater than market value. Will she do it? Hell yes, she will. Let's look at how much this move saved her. If she had not purchased the put option, she would have sold her 100 lame shares at $20 a pop. 100 shares times $20 a share is $2,000. But Lily will exercise her option to sell her 100 shares at $25 a price. So 100 shares times $25 a share minus a $5 premium is two thousand four hundred and ninety five dollars.

So through exercising the put option, Lily was able to make four hundred and ninety five dollars more than she would have by selling her shares on the open market. Let's look at scenario number two. On March 17th, Lily wakes up to find L.A.M.E. stock is trading at $30 a share. In this scenario, Lily has the option to sell her shares at $25 a share, and the market price of the stock is $30 a share. The choice here boils down to whether or not she wants to sell her shares for less than what she can get on the open market. Her answer? Hell to the no! Why would she give the market a discount on the shares that she bought with her hard-earned money? She wouldn't. So she would let the option expire, and if she wants to sell her shares, she can at the $30 a share market price.

So as you're seeing, put options act almost like an insurance policy. In this example, Lily had reason to believe that the price of LAME shares may go down. By buying a put option, Lily created a little safety net for herself so she could sell her shares for more than the market value. How are we feeling? This isn't so bad, right? Okay, well, I do have to add on one more layer. In today and yesterday's episode, we were looking at long positions. In long positions, you're the one buying the option. Whether it be a put option or a call option, you're in control. There is a way you can sell options called a short position. Taking a short position with options is very risky,

and I don't recommend money rehabbers try this at home. That said, I do think you should understand how this money move works. A short position is basically the opposite side of Lily's transaction. Let's say that person on the other side of Lily's transaction is named Sammy Short. If Sammy takes a short position on a call option, he is selling the option for an investor to buy his shares at a certain price. And if he's taking a short position on a put option, he is selling the option for an investor to sell him the shares for a certain price. The tricky thing about selling options is exactly that. You are selling the option, the decision-making power, the control,

if you will, to another investor. Let's revisit the last example. Say Lily had purchased the put option from Sammy. In non-finance speak, this means that Sammy sold Lily the option to sell her lame shares to him at $25 a share. That would mean that if scenario one played out and on the expiration date, LAME shares were trading at $20 a share and Lily decided to exercise the option, Sammy would have to buy Lily's shares at $25 a share, meaning he would have to buy Lily's shares, even though that means he's buying shares for a higher price than he would actually spend if he was just buying them on the open market. In short, pun intended, with short options, you might need to fulfill an obligation that ends up losing you money. I want to leave you with a little cheat sheet

on these positions. With a long position, you're buying the call option because you think the price will go up. With a long position, you're buying a put option because you think the price will go down. With a short position, you're selling the call option because you think the price will go down. With a short position, you're selling the call option because you think the price will go down. With the short position, you're selling a put option because you think the price will go up. For today's tip, you can take straight to the bank. I'm going to echo what I said yesterday. If you're interested in buying a call option, you should talk with a representative at your brokerage first, or even better, your fiduciary. Have that person walk you through your first options order. The long and the short of it is, this is a pro move, and I'd recommend practicing much less

risky investments with your hard-earned money. Money Rehab is a production of iHeartRadio your host nicole lappen our producers are morgan lavoie and mike coscarelli executive producers are nikki etor and will pearson our mascots are penny and mimsy huge thanks to og money rehab team michelle lands for her development work katherine law for her production and writing magic, and Brandon Dickert for his editing, engineering, and sound design. And as always, thanks to you for finally investing in yourself so that you can get it together and get it all.