Put options entail a much lower cost, minimize your loss to the premium paid, butcarries greater volatility in price movement and therefore increases your risk per eachunit of price change.for example, xyz inc. trading at $50 per share (eligible for reduced margin) looks likea candidate for a short sale. so you decide to sell short 100 shares at a cost of $1,500to you (your $1,500 plus the $5,000 proceeds from the short sale are required toinitiate the transaction).but lets say the august 50 put options on xyz inc. are trading at $3.25. since eachput option contract controls 100 shares, you could control 100 shares for a cost of$3.25 x 100 = $325. so rather that hand over $1,500, you could control the samenumber of shares for $325.lets say the underlying stock drops from $50 to $45 the next day. your profit on theshort sale would be $500 ($50 - $45 = $5 profit per share x 100 = $500). thats areturn on your money of about 33% ($500 profit / $1,500 cost).the option price would jump from $3.25 to approximately $8.25. your profit on the putoption would be $500 in this case ($8.25 - $3.25 x 100 = $500 profit). that representsa return of about 153% on your money ($500 / $325).what if the price went from $50 to $60 and you still held your investment? you wouldbe facing a pretty big loss on your short sale, but the maximum you could lose on yourput option is limited to the premium you paid (i.e., maximum loss would be $325).while the $325 loss represents a 100% loss on your investment option, the dollarfigure is much lower than the loss you would be facing on your short sale.of course, the drawback on the put option is the volatility of the price changes. it onlytakes a small price move to wipe out a good portion of your option investment, whilethe same small price move would represent a much smaller loss on your short sale.
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