I was wondering if anyone could help me understand why put options cost money (they have value) when a stop-loss order could be placed for free?
Intuitively, I understand why, but when I really think about it, does the option premium for a protective put really just reflect that it guarantees you can execute at a specific price versus. stop loss where you might not get that price if markets gap down or something? There’s got to be more to it that I am missing…
Primarily, with a stop-loss there’s order there’s no guarantee that you’ll sell the underlying, whereas with a put option there is (barring counterparty default.
And i suppose this would only apply to a situation where it was a protective put (i.e. the underlying asset was owned). Whereas there is no way to place a “naked” stop-loss. Thanks!
Good point!
My pleasure.
Further to what you already wrote - with a put option in a protective put you can sell it back to the market and potentially make money (or at least get some money) prior to the underlying decreasing to the strike price. You could in theory make some money by selling your originally OTM put option that’s now approaching being ATM or ITM, and then just do a stop order to make your exit from the holding. With a stop order, it’s just an order you can’t sell it back to the market for value. There’s nothing but the instruction given to the broker. A broker instruction plus one dollar will buy you a soda. An option (call or put) is an exchange traded commodity that will increase or decrease in value over time and is generally liquid. At least for the purpose of the exam.