A:

It seems counterintuitive that you would be able to profit from an increase in the price of an underlying asset by using a product that is most often associated with gaining from falling prices. However, as you'll see with the two methods below, it is possible.

A put option gives the purchaser the right to sell the underlying at the agreed upon strike price, regardless of how far the price declines. For this right, the trader pays a premium, which in turn is kept by the writer of the option if the price of the asset closes above the strike price at expiration. Looking at this transaction from the perspective of the option writer rather than that of the purchaser, it becomes apparent that when an option trader has a bullish outlook on a security, he or she can collect a premium by selling put options and keep the premium when the options expire worthless.

The downside to using this strategy is the amount of risk associated with holding a short position in a put option. Therefore, this strategy should only be attempted by traders who understand all the risks, so that the likelihood of significant losses is reduced. (To learn more about this strategy, see Introduction To Put Writing.)

One method of avoiding the risk associated with a short put option is to implement a strategy known as a bull put spread. This strategy is created by selling one put option and buying another with a lower strike price. In this case, the lower put option protects the trader from large declines in the price of the underlying because the gains from a move below the strike help offset the losses the trader incurs when the original holder of the long position exercises his or her options. This strategy also has a limited profit potential equal to the difference between the amount collected from selling the option and the price paid to acquire the other option. Profiting from an increase in the price of an underlying asset by using a product that is associated with declining prices may seem attractive, but it is extremely important that you have a good understanding of the risks and payoffs associated with both of these strategies before you incorporate them into your trading.

For further reading on put options, see Trading The QQQQ With In-The-Money Put Spreads.

RELATED FAQS
  1. When is a put option considered to be "in the money"?

    Learn about put options, what they are, how these financial derivatives operate and when put options are considered to be ... Read Answer >>
  2. How can derivatives be used to earn income?

    Learn how option selling strategies can be used to collect premium amounts as income, and understand how selling covered ... Read Answer >>
  3. When does one sell a put option, and when does one sell a call option?

    An investor would sell a put option if her outlook on the underlying was bullish, and would sell a call option if her outlook ... Read Answer >>
  4. How do I set a strike price in a put?

    Learn about put options, considerations to make before you select strike prices and how to select strike prices for your ... Read Answer >>
  5. Do options make more sense during bull or bear markets?

    Understand how options may be used in both bullish and bearish markets, and learn the basics of options pricing and certain ... Read Answer >>
  6. How do traders combine a short put with other positions to hedge?

    Learn how sold puts can be utilized in different types of hedging strategies, and understand some of the more common option ... Read Answer >>
Related Articles
  1. Trading

    Three Ways to Profit Using Put Options

    A brief overview of how to profit from using put options in your portfolio.
  2. Trading

    Bear Put Spreads: A Roaring Alternative To Short Selling

    This strategy allows you to stop chasing losses when you're feeling bearish.
  3. Trading

    Profiting From Stock Declines: Bear Put Spread Vs. Long Put

    If you're bearish, you should compare the risk/reward characteristics of these two strategies.
  4. Trading

    Options Hazards That Can Bruise Your Portfolio

    Learn the top three risks and how they can affect you on either side of an options trade.
  5. Trading

    Options Strategies for Your Portfolio to Make Money Regularly

    Discover the option-writing strategies that can deliver consistent income, including the use of put options instead of limit orders, and maximizing premiums.
  6. Trading

    How To Sell Put Options To Benefit In Any Market

    As long as the underlying stocks are of companies you are happy to own, put selling can be a lucrative strategy.
  7. Trading

    The Basics of Options Profitability

    The adage "know thyself"--and thy risk tolerance, thy underlying, and thy markets--applies to options trading if you want it to do it profitably.
  8. Trading

    When Should I Sell A Put Option Vs A Call Option?

    Beginning traders often ask not when they should buy options, but rather, when they should sell them.
RELATED TERMS
  1. Bull Put Spread

    A type of options strategy that is used when the investor expects ...
  2. Short Put

    A type of strategy regarding a put option, which is a contract ...
  3. In The Money

    1. For a call option, when the option's strike price is below ...
  4. Option

    A financial derivative that represents a contract sold by one ...
  5. Bear Put Spread

    A type of options strategy used when an option trader expects ...
  6. Call On A Put

    One of the four types of compound options, this is a call option ...
Hot Definitions
  1. Fintech

    Fintech is a portmanteau of financial technology that describes an emerging financial services sector in the 21st century.
  2. Ex-Dividend

    A classification of trading shares when a declared dividend belongs to the seller rather than the buyer. A stock will be ...
  3. Debt Security

    Any debt instrument that can be bought or sold between two parties and has basic terms defined, such as notional amount (amount ...
  4. Taxable Income

    Taxable income is described as gross income or adjusted gross income minus any deductions, exemptions or other adjustments ...
  5. Chartered Financial Analyst - CFA

    A professional designation given by the CFA Institute (formerly AIMR) that measures the competence and integrity of financial ...
  6. Initial Coin Offering (ICO)

    An Initial Coin Offering (ICO) is an unregulated means by which funds are raised for a new cryptocurrency venture.
Trading Center