In a recent trade, I bought a put option on May 12, 2014.
The put option is 2 PUT .RY 5/17/14 $74.00 for total cost of $131.95 after commission. When an
individual BUYS an option, the individual has to pay the premium and its commissions up front. An option buyer has the right, but not the obligation, to sell 100 shares at the strike price before or on the expiration date. Since I bought to open 2 contracts, that would mean 200 shares. I paid $120.00 premium plus a commission.
On May 15, 2014, I sold to close this option at $0.75 per contract for a total of $150.00 excluding commission.
Purchase of Put : $120.00 = 2*100*$0.60
Commission on Purchase : $11.95
Sale of Put : $150.00 = 2*100*$0.75
Commission on Sale : $11.95
Profit = $6.10
Return on Investment = [2*100*( .75-.60) - 23.90] / (2*100*0.60)]
As I was getting close to the expiration day of May 17,2014, I took a small return to reduce the chance of losing money then trying to get a bigger return and losing $131.95.
There are different reasons to buy a put option. If you expect the market to go down and you want to profit from it, you can either short the stock or buy a put option. Short selling has unlimited risk as a stock price can keep going up and up. When an investor/trader buys a put option, they only risk
what they paid in total for the put option. Therefore, buying a put option reduces the risk.
EDIT: "As I was getting close to the expiration day of May 17,2014 ..." was worded wrong, as it reads correctly now.