A put option is a contract that gives its holder the right to sell a set number of equity shares at a set price, called the strike pricebefore a certain expiration date.
That's a question that investors sometimes struggle with because it's not always clear if it's the optimal time to call buy the shares or put sell the stock when holding a long call option or a long put option. There are a number of factors to consider when making the decision, including how much time value is remaining in the option, whether the contract is due to expire soon, and whether you really want to buy or sell the underlying shares. Conversely, a put option represents the right to sell the underlying shares.
If the option is exercisedthe writer of the option contract is obligated to purchase the shares from the option holder. 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 Work There are a number of ways to close out, or complete, the option trade depending on the circumstances. If the option expires profitable or in the moneythe option will be exercised.
If the option expires unprofitable or out of the moneynothing happens, and the money paid for the option is lost. A put option increases in value, meaning the premium rises, as the price of the underlying stock decreases. Conversely, a put option's premium declines or loses value when the stock price rises.
Exercise means to put into effect the right to buy or sell the underlying financial instrument specified in an options contract. In options trading, the holder of an option has the right, but not the obligation, to buy or sell the option's underlying security at a specified price on or before a specified date in the future.
Put options provide investors a sell-position in the stock when exercised. As a result, put options are often used to hedge or protect from downward moves in a long stock position.
To complete the transaction, an option writer will need to purchase the shares at that price. But he might have believed that the stock price could rise. He was willing to pay the option premium for that protection. If Max doesn't own shares, the option can be exercised to initiate a short position in the stock.
A short position is when an investor sells the stock first with the goal of buying the stock or covering it later at a lower price. Initiating a short position requires a margin account with enough money in it to cover the margin on the short trade. The account is typically collateralized by cash or securities.
Understand an Out of the Money Option and How to Hedge It
Investors should be careful with shorting stocks since a stock could potentially increase in price. If the stock price rises rapidly, many traders might cover their short positions by buying the stock to unwind their short trades. Selling the Option An alternative to exercising an option is to sell the option contract back to the market.
- When can I exercise my stock options?
- Options Exercise
- Material terms of an option agreement
- Should an Investor Hold or Exercise an Option?
- Styles[ edit ] The option style, as specified in the contract, determines when, how, and under what circumstances, the option holder may exercise it.
- Article Reviewed on July 30, Michael J Boyle Updated July 30, As you learn about trading optionsyou'll find that options traders use terms that are unique to options markets.
- Mark Wolfinger Updated November 25, Trading using options is a method traders use to try to purchase investments at an optimum price.
- Exercising Stock Options - Fidelity
Selling the option is both the easiest and the most commonly used method of closing an option position. In other words, there is no exchange of shares; instead, the investor has a net gain or loss from the change in the option's price.
Behind the jargon of stock option trading
Benefits of Selling the Option There are many benefits to selling an option, such as a put, before the expiry instead of exercising it. Closing out a put trade by simply selling the put is popular because most brokers charge higher fees for exercising by whom the option can be exercised option compared to the commission for selling an option.
If you're considering exercising an option, find out how much your broker charges since it could impact your profits, especially on smaller trades.
Broker fees vary widely. If you're thinking of starting a trading account, Investopedia has created a list of the best options brokers to help you get started. Compare Accounts.
Initiate an Exercise-and-Sell Transaction cashless Hold Your Stock Options If you believe the stock price will rise over time, you can take advantage of the long-term nature of the option and wait to exercise them until the market price of the issuer stock exceeds your grant price and you feel that you are ready to exercise your stock options. Just remember that stock options will expire after a period of time.