Put on a Put
A put on a put is an options contract that gives the holder the right to sell an underlying put options contract. 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. If the trader is correct and the asset falls, the option is in the money and can be exercised, with the trader profiting from the difference between the option price and the market price. **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. Essentially, a put on a put option is an option to sell an option.
What Is a Put on a Put?
A put on a put is an options contract that gives the holder the right to sell an underlying put options contract. The put on a put trade is one of four types of compound options.
Essentially, a put on a put option is 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 United States.
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 (the strike price) by a specified expiration date. If the trader is correct and the asset falls, the option is in the money and can be exercised, with the trader profiting from the difference between the option price and the market price.
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 option.
Note that compound options are more common in Europe, and European options can be exercised only on the expiration date. An American option can be exercised on or anytime 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 to employ 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:
These options are also known as split-fee options.
Related terms:
American Option
An American option is an option contract that allows holders to exercise the option at any time prior to and including its expiration date. read more
Call on a Call
A call on a call is a type of compound option that gives the holder the right to buy a different plain vanilla call option on the same underlying security. read more
Chooser Option
A chooser option allows the holder to decide whether it is a call or put after buying the option. It provides greater flexibility than a vanilla option. read more
Compound Option
A compound option is an option for which the underlying asset is another option, thus two strike prices and two exercise dates. read more
European Option
A European option can only be exercised on its maturity date, unlike an American option, resulting in lower premiums. read more
Expiration Date (Derivatives)
The expiration date of a derivative is the last day that an options or futures contract is valid. read more
In The Money (ITM)
In the money (ITM) means that an option has value or its strike price is favorable as compared to the prevailing market price of the underlying asset. read more
Leverage : What Is Financial Leverage?
Leverage results from using borrowed capital as a source of funding when investing to expand a firm's asset base and generate returns on risk capital. read more
Options Contract
An options contract gives the holder the right to buy or sell an underlying security at a predetermined price, known as the strike price. read more
Put on a Call
One of four compound options types, a put on a call is a put option for which the underlying is a call option. read more