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A put option is a contract that allows the option holder to sell a number of underlying securities at an agreed-upon price before a certain date. The price at which put option’s securities are sold is known as the "strike price."
When the option is exercised, the writer or issuer of the option isobligated to buy the option at the strike price. Exercising means theowner of the option is using their right to sell the option to earn a profitfrom it according to the given norms while the option was formed.
Note − The writer of a put option is often a bank or other financial intermediary that is obligated to buy the put option when it is exercised. The rules of buying and selling are however determined prior to the sale of the option by the writer to the option holder.
Put options should be exercised when they are in the money, meaningthat the strike price is higher than the value of the underlying asset. If the price of the underlying is less than the strike price, the option owner can sell the option to earn a profit from it. However, if the option is at the money or out of the money, there is no use in exercising it as no intrinsic value can be derived from the exercise.
An alternative to exercising the option is to sell it back in the market. Selling is the easiest and most popular way of closing a put option as it does not need any time or involves no cost for short-selling. In selling, there is no exchange of shares, only the investors get a net gain or loss from it due to the current market price of the underlying asset.
Note −The only best time to exercise a put option is when the option is in the money. In all other cases, it is unprofitable to sell the option, and hence selling the option in the market is the best option in case of put options.
There are many benefits of selling put options instead of exercising them.The asset prices underlying an option keep changing frequently over timeand they may be deep in the money or far out of the money. Trading insuch situations can be tiresome and risks may go up extensively in suchcases. This makes the put option selling far more enriching thanexercising them.
The brokerage charged for exercising may be big enough to deter oneaway from exercising the puts. Many brokers charge huge amounts ofcommission for exercising the put options which leaves the owners barepocketed after an exercise. Selling the put option in such circ*mstancesmay be more rewarding and profitable.
In the realm of finance and investment, my expertise lies in options trading, particularly put options. I've delved deep into understanding the mechanics, strategies, and implications of these financial instruments. Let's break down the concepts within the article to provide a comprehensive understanding:
Put Options:
A put option is a financial contract granting the holder the right, not obligation, to sell a specified quantity of an underlying asset at a predetermined price (the strike price) within a specific timeframe. Here's the breakdown of the key components mentioned in the article:
- Strike Price: This is the pre-agreed price at which the underlying asset will be sold if the put option is exercised.
- Option Writer: Typically, a financial institution or intermediary that sells the put option and is obligated to buy the underlying asset if the option holder exercises their right.
Exercising Put Options:
- In the Money: When the market price is lower than the strike price, making it profitable to exercise the option.
- At the Money/Out of the Money: When the market price is equal to or higher than the strike price, it's usually unprofitable to exercise the option.
Alternatives to Exercising:
- Selling the Option: This involves trading the option contract itself rather than exercising it, allowing the holder to profit or incur losses based on the current market price of the underlying asset.
Advantages of Selling Put Options Instead of Exercising:
- Flexibility and Convenience: Selling the put option provides flexibility without the necessity of dealing with the underlying asset.
- Reduced Risk: Market fluctuations can increase risks associated with exercising options, while selling them can mitigate such risks.
- Cost Considerations: Exercising options might involve substantial brokerage fees, making selling a more profitable alternative.
The rationale behind selling put options over exercising them often stems from minimizing costs, reducing risks, and maximizing profitability.
Understanding the dynamics of options trading, especially put options, involves grasping these concepts to make informed decisions aligned with market conditions, risk tolerance, and investment objectives.
