Financial Markets For The Rest Of Us
An Easy Guide To Money, Bonds, Futures, Stocks, Options, And Mutual Funds
options because that would mean that the holder would sell you 200 shares of Ford at $50, when they can sell them in the stock market for $60. If they did force you to buy, more power to you. So you would be forced to buy 200 shares of Ford at $50 and you can then turn around and sell them for $60 for a profit of $10 per share or $2,000 total. Of course this would never happen, and that's why those options you sold would expire and you keep the original $400 profit.
If, however, Ford has dropped to $40 and the options are just before expiration, the stock is put to you (trading lingo for when put options are exercised, just like call options when the stock is assigned), meaning that you would have to buy the 200 shares from the option holder at $50 per share. Clearly a loss for you when Ford is trading at $40.
As usual, put options are normally not exercised until the expiration date. At that time if the stock has moved lower than the strike price of the put options, then you, as the writer, would be expected to buy those shares (i.e., the stock is put to you). This could translate into a loss for you if the stock has moved sufficiently lower than the option's strike price that selling those shares that you had to buy would wipe out your original proceeds from writing the puts. Of course you don't have to sell the shares that have been put to you. Your obligation ends when you buy the shares. But technically you still have a loss since you pay a higher price for those shares than you would if you just bought them on the stock market. On the other hand if the stock price has moved higher than the strike price, then the puts would expire worthless, and with your obligation terminated you are free to enjoy the proceeds you received from writing them. Of course at any time prior to expiration you can settle your short position by buying the same contracts with the same quantity, but if the stock has moved lower in price at the time of settlement, you would be paying more for those options that you received by writing them for a net loss. …
Table of Contents