What Is a Put on a Put?
A put on a put, in options trading, is an options contract that gives its buyer the right to sell an underlying options contract. The put on a put trade is one of four types of compound options.
The scenario can be described as follows:
- An investor buys a put option, which authorizes that investor to sell a given stock at a particular price on a particular date. This is sometimes called the vanilla option.
- Another investor buys a put option on the vanilla put option. That authorizes this other investor to sell the underlying put option on the expiration date. This is also known as the split-fee option.
So, the put on a put option is essentially an option to sell an option. The underlying asset of the put on a put option is the original option.
Put on a put options are more common on European exchanges than in the U.S.
Put on a Put Explained
The buyer of a put option is a trader who expects the asset upon which the option is based to fall in price. The trader purchases a put option, usually for 100 shares, that allows the shares to be sold at a certain price (or strike price) by a set expiration date. If the trader is right and the asset drops in price, the option is exercised and the trader makes the difference between the option price and the market price.
- A put on a put is an options contract that gives its buyer the right to sell an underlying options contract.
- The underlying asset of the put on a put option is the original option.
- A put on a put is essentially an option to sell an option.
When an investor buys a put option, it includes the right to sell the stock or underlying security before the expiration date. Most put options allow investors to sell the stock back to the trader who sold the options to them.
A put on a put option involves two put options, one over the other.
A put on a put has two strike prices and two expiration dates. One is for the compound put option and the other is for the underlying vanilla put option.
Note that compound options are more common in Europe, where they can be exercised only on the expiration date. An American-style option can only be exercised before the date of expiration.
Since one of the variables that determine the cost of an option is the price of the underlying asset, the cost of a put on a put option will generally be lower than the cost of a vanilla put on the corresponding asset. Thus it can provide some leverage to the options trader.
When to Use a Put on a Put
A put on a put option is used when a trader wants leverage. The trader will also be moderately bullish on the underlying asset. The value of a put on a put changes in direct proportion to the price of the underlying asset. This means the value increases as the asset price increases and decreases as the asset price decreases.
Other Compound Options
The other three types of compound options are:
- Call on a put: This is a call option on an underlying put option. The owner who exercises the call option receives a put option.
- Call on a call: In this option, the investor buys another call option with customized provisions. These provisions include the right to buy a plain vanilla call option on an underlying security.
- Put on a call: The investor must deliver the underlying call option to the seller and collect a premium based on the strike price of the overlying put option.
These options are also known as split-fee options.