How Is a Put Option Exercised?

What Is a arrange Option ?

A put option is a contract that gives its holder the veracious to sell a set number of fairness shares at a set price, called the strike price, before a certain exhalation date. If the option is exercised, the writer of the choice narrow is obligated to purchase the shares from the option holder. “ Exercising the option ” means the buyer is opting to take advantage of the right field to sell the shares at the strike price .

The reverse of a put option is a birdcall option, which gives the contract holder the right to purchase a set amount of shares at the strike price anterior to its exhalation.

Key Takeaways

  • A put option is a contract that gives its holder the right to sell a number of equity shares at the strike price, before the option’s expiry.
  • If an investor owns shares of a stock and owns a put option, the option is exercised when the stock price falls below the strike price.
  • Instead of exercising an option that’s profitable, an investor can sell the option contract back to the market and pocket the gain.

How Put Options sour

There are a number of ways to close out, or dispatch, the option trade depending on the circumstances. If the option expires profitable or in the money, the choice will be exercised. If the option expires unprofitable or out of the money, nothing happens, and the money paid for the choice is lost .

A put option increases in value, meaning the agio rises, as the price of the underlying stock certificate decreases. conversely, a place option ‘s premium declines or loses value when the stock price rises. Put options provide investors a sell-position in the stock certificate when exercised. As a consequence, put option options are much used to hedge or protect from down moves in a long stock position .

exercise of a Put Option Transaction

Max purchases one $ 11 put choice on Ford Motor Co. ( F ). Each choice contract is worth 100 shares, so this gives him the right to sell 100 shares of Ford at $ 11 before the passing go steady .

If Max already holds 100 shares of Ford, his agent will sell these shares at the $ 11 strickle price. To complete the transaction, an choice writer will need to purchase the shares at that price .

Max may realize a reach on the choice if the price of Ford stock falls below the $ 11 hit price. In other words, Max is protected from the stock price falling below the $ 11 strike price of the put choice. however, the actual profit is besides dependant on how much Max gainful ( the premium ) for the option. In other words, if Ford were to fall to $ 10 per contribution, but Max paid $ 2 per share for the choice shrink, the breakeven point would be $ 9 per contribution ( $ 11 – $ 2 ). If Ford were to fall below $ 9 per share anterior to expiry Max would make a profit .

Let ‘s say the stock falls to $ 8 per share. Max would be able to sell 100 shares at $ 11 alternatively of the current $ 8 market price. By buying the option, Max has saved himself $ 300 ( less the monetary value of the choice ), since he has sold 100 shares at $ 11, for a sum $ 1,100, alternatively of having to sell the shares at $ 8 for a total $ 800 .

Max could have sold his malcolm stock at $ 11 and not bought a put option. But he might have believed that the sprout price could rise. He did n’t want to sell the malcolm stock, but he did want protection in sheath the stock ‘s price dropped. He was volition to pay the choice premium for that protection .

case of a short Position Transaction

now let ‘s assume that Max does not actually own shares of Ford but has bought the $ 11 put, and the stock is presently trading at $ 8. He could purchase shares of Ford at $ 8 and then have the broker exert the option to sell the shares at $ 11. This would net Max $ 300, less the cost of the option agio, fees, and commissions .

If Max does n’t own shares, the option can be exercised to initiate a short side in the stock. A short position is when an investor sells the neckcloth first with the goal of buying the stock or covering it late at a lower price. Since Max does n’t own any shares to sell, the place option will initiate a curtly position at $ 11. He can then cover the short side by buying the stock at the current market price of $ 8, or continue to hold the light position .

Initiating a abruptly position requires a margin history with enough money in it to cover the margin on the light trade. A margin account is a brokerage house account in which the customer borrows money or shares from the broke to finance a farseeing ( buy ) or short-change ( sell ) position. The account is typically collateralized by cash or securities .

Investors should be careful with shorting stocks since a malcolm stock could potentially increase in price. If the stock certificate price rises quickly, many traders might cover their light positions by buying the stock certificate to unwind their inadequate trades. The rush of short traders into buying the stock could exacerbate the motion higher in the livestock ‘s price–called a short-squeeze .

Selling the choice

An alternative to exercising an option is to sell the choice sign back to the commercialize. Selling the option is both the easiest and the most normally used method of closing an option position. In other words, there is no exchange of shares ; rather, the investor has a net advance or passing from the change in the option ‘s price .

For model, the $ 11 invest may have cost $ 0.65 x 100 shares, or $ 65 ( plus commissions ). Two months late, the choice is about to expire, and the stock is trading at $ 8. Most of the time value of the option has been eroded, but it still has an intrinsic value or net income of $ 3, so the option may be priced at $ 3.10. Max bought his option for $ 65 and can now sell it for $ 310 .

In the scenarios above, you must consider the cost of the option bounty ( $ 65, in this case ) to calculate the net income advantage from exercising the option .

Benefits of Selling the option

There are many benefits to selling an option, such as a arrange, before the termination rather of exercising it. option premiums are in changeless magnetic field, and purchasing invest options that are deep in the money or far out of the money drastically affects the option premium and the possibility of exercising it .

Closing out a invest trade by plainly selling the put is popular because most brokers charge higher fees for exercising an option compared to the commission for selling an option. If you ‘re considering exercising an option, find out how a lot your broke charges since it could impact your profits, specially on smaller trades .

Broker fees vary widely. If you ‘re thinking of opening a trade account, make sure to compare different options brokers before getting started .

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