Put options 101

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Put options 101

Postby jwblue » Wed Dec 26, 2012 4:19 am

Lets say I buy a put option to sell 100 shares for $170 each.

The stock goes down to $50.

What if I want to exercise the put option and the person does not have the funds to buy the shares from me for $170 x 100?

Is he forced to buy regardless if he has the funds?

Am I SOL or does the brokerage of the put seller eat that loss?

2nd Question:

Can I buy a put option without owning the stock?

Say I buy a put option for $170. If the stock goes down to $50.00. I buy the stock for $50.00, then exercise the put option.

Is my loss limited to the cost of the put option? It seems a great way to short a stock.

What if I do not own the stock and the stock goes down to 0 overnight? Can I still exercise the put and make the profit?
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Re: Put options 101

Postby Valuethinker » Wed Dec 26, 2012 5:33 am

jwblue wrote:Lets say I buy a put option to sell 100 shares for $170 each.

The stock goes down to $50.

What if I want to exercise the put option and the person does not have the funds to buy the shares from me for $170 x 100?

Is he forced to buy regardless if he has the funds?

Am I SOL or does the brokerage of the put seller eat that loss?


The exchange monitors his loss on the position each day. If he exceeds his margin, his margin is called, and his position closed out. That's how they control counterparty risk. Over The Counter options (OTC) you have no such protection (you write what you want into the contract).

2nd Question:

Can I buy a put option without owning the stock?

Say I buy a put option for $170. If the stock goes down to $50.00. I buy the stock for $50.00, then exercise the put option.


No you just exercise the put option. You receive the stock in return for the $50. Buying it would reverse your position. If your Strike was $170, the underlying drops to $50, and your option premium was $10, then you'd make $170-50 - 10 = $110. You've also lost the interest on the $10 since you bought.

Is my loss limited to the cost of the put option? It seems a great way to short a stock.


You would make a profit on the difference between the Strike Price and the price at exercise less the Option Premium (what you pay for the option contract to the writer/ seller).

What if I do not own the stock and the stock goes down to 0 overnight? Can I still exercise the put and make the profit?


Yes. An American Option allows exercise at any time up to expiry. A European Option allows exercise only at expiry. (from memory, an Asian Option is a combo of the two).

Don't think that traded options are an inefficient market. They are highly efficient although transactions charges are large.

Also, US tax law, I think you'd pay ST capital gains tax? In Canadian tax law, if the government decided you were an options professional, you'd pay income tax.
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Re: Put options 101

Postby jwblue » Wed Dec 26, 2012 12:40 pm

No you just exercise the put option. You receive the stock in return for the $50. Buying it would reverse your position. If your Strike was $170, the underlying drops to $50, and your option premium was $10, then you'd make $170-50 - 10 = $110. You've also lost the interest on the $10 since you bought.


I am under the assumption that I never own the stock. What does "buying it would reverse your position" mean? Do I actually buy the put at that time? I thought I buy it earlier speculation the stock will go down.
Or do you mean that buying it AUTOMATICALLY reverses my position?

One more question.



On my Options Chain, for PNRA there is a Put with an ask for 14.50 with a strike price of $170 in 24 days.
I thought when I buy a put option it is the right to sell 100 shares. Is that for 1 share?

If it is for 100 shares that would not make sense.

The current share price is $156,74.

Does that mean in 24 days if the price is $158 which would not be unreasonable, I could exercise the Put Option and make ($170 - 158) x 100 = $120 which is all for a $14.50 risk?
Last edited by jwblue on Wed Dec 26, 2012 12:54 pm, edited 1 time in total.
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Re: Put options 101

Postby Dave_M » Wed Dec 26, 2012 12:50 pm

In your example (170 - 158) = 12 * 100 = 1200.

But you would pay 14.50 * 100 = 1450 for the option.

Not a good outcome.

edited twice; once to remove snarky comment 8-) , once to correct math typo :oops:
Last edited by Dave_M on Thu Dec 27, 2012 4:36 pm, edited 2 times in total.
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Re: Put options 101

Postby jwblue » Wed Dec 26, 2012 1:17 pm

From my example above, In order to exercise the put option, do I need to have the funds in my account to buy the shares for $50 and then sell them at the higher price?
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Re: Put options 101

Postby indexfundfan » Wed Dec 26, 2012 3:04 pm

jwblue wrote:From my example above, In order to exercise the put option, do I need to have the funds in my account to buy the shares for $50 and then sell them at the higher price?

Yes, you will need sufficient equity in the account to exercise (buy) the shares.

But, you could also just close (sell) out the put option at a profit. No reason to exercise the option, get the shares, then sell the shares. In addition, in many brokerages, it costs more to exercise an option than to trade stocks.
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Re: Put options 101

Postby FinancialDave » Wed Dec 26, 2012 8:41 pm

This thread seems anything but "put options 101."
Let's straighten out a few things:
1. When you buy a put option on a stock there are really only a couple of "sensible" things you would do - mainly because of the premiums involved.
a) If the price of the option has gone up from the time you bought it you could sell the option back prior to its expiration.
b) At expiration if the put is still in the money by I think it is now 1 cent (use to be more), and you do not tell your broker otherwise, then you will be forced to sell (or you will be shorted the number of shares times 100 the # of puts that are in the money. In other words say you owned 600 shares of GE stock and you let your 6 GE puts expire in the money, your 600 GE shares will be sold at the strike price of the option. If you don't own any GE shares, on Monday morning you will be short 600 GE shares. If your account is not a margin account (such as an IRA) then you will probably not be able to hold these shares short unless you have a sizeable cash position to cover the short shares should the price rise, and so the broker will probably have to buy back the shares within 2-3 days in order to cover, thus you could loose more money depending on where the GE shares went during that time. The better option if this happens (normally you try not to let it happen by selling the options before expiration,) is to call your broker and just give him a "do not exercise" order and that will save you the pain of selling the shares - but you will of course loose all your "in the money premium" that was still left in the option.

Of course if the option is out of the money at expiration there is nothing more you can do as you just lost all the money paid for the option.

In most cases you would never exercise the option before expiration as this would be more costly than just selling your shares and the option outright.

fd
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Re: Put options 101

Postby FinancialDave » Wed Dec 26, 2012 8:50 pm

The other side to the person buying the put option is the person "writing" (selling) the put option. This person collects a premium in his account initially and when the option expires in the money, he will be forced to buy the shares of the stock at the strike price. He will however get to keep the premium that was paid to him as the original "seller" of the option.

If the option expires out of the money the "writer" still keeps the premium.

Note: the buyer of the put option is hoping the stock price will go down, while the seller of the put option is hoping the price will go up.

fd
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Re: Put options 101

Postby Valuethinker » Thu Dec 27, 2012 3:27 am

jwblue wrote:
No you just exercise the put option. You receive the stock in return for the $50. Buying it would reverse your position. If your Strike was $170, the underlying drops to $50, and your option premium was $10, then you'd make $170-50 - 10 = $110. You've also lost the interest on the $10 since you bought.


I am under the assumption that I never own the stock. What does "buying it would reverse your position" mean? Do I actually buy the put at that time? I thought I buy it earlier speculation the stock will go down.
Or do you mean that buying it AUTOMATICALLY reverses my position?


Yes. In that if you buy a stock and hold the put, your payoff diagram goes flat at the strike price and below (you don't lose money) and is that of owning the stock (less the cost of the put) if the price is above the Strike price.


One more question.



On my Options Chain, for PNRA there is a Put with an ask for 14.50 with a strike price of $170 in 24 days.
I thought when I buy a put option it is the right to sell 100 shares. Is that for 1 share?

If it is for 100 shares that would not make sense.

The current share price is $156,74.

Does that mean in 24 days if the price is $158 which would not be unreasonable, I could exercise the Put Option and make ($170 - 158) x 100 = $120 which is all for a $14.50 risk?


over to Dave, above.
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Re: Put options 101

Postby FinancialDave » Thu Dec 27, 2012 11:51 am

Each option is for 100 shares, so to buy 1 $14.50 option will cost you $1450. If the price rises above $170 in the next 24 days and you don't sell the option before it does you will lose all your money.


If the price is at $158, and you sold the option, you would lose $250 per option contract (buy for $1450 sell for $1200). Once again I do NOT recommend exercising the option, this is just a way to lose more in transaction costs.

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Re: Put options 101

Postby FinancialDave » Thu Dec 27, 2012 12:19 pm

Also remember when you buy a put option you are hoping the stock price will go down.

So if you buy the $170 put when the stock price is $155 and you later sell the option (or worse exercise the option) when the stock price is $158, you have most CERTAINLY lost money. The amount you will have lost will be the total of the following:

1. $300 per contract for the change in stock price
2. Two commissions to buy and sell the option( or more if you exercise it.)
3. The bid ask spread of the options - you buy at the ask and sell at the bid.
4. The time value that has decayed in the option, based loosely on the number of days you hold the option before selling, the volatility of the market, and how far it was in or out of the money when you bought it.

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