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  • Elias Zeekeh, MBA, CPA, CMA

What are put options and why would I want to sell them?

Put options are a contract which gives the buyer the right but not the obligation to sell a specified amount of an underlying security within a time range at a specific price. Conversely if you are the seller or writer of a put option you have the obligation to buy the security at a predetermined price within that time range from the buyer.

So, for example let’s say shares of ABC Corp are currently trading for $100 per share. Investor A is bearish on ABC Corp., so they buy a 1 put option contract for $2 per share (1 contract represents 100 shares) from Investor B at an exercise price of $80 expiring in 90 days. Therefore, Investor A at the time of purchasing the option would pay Investor B $200.00 ($2 x 100 shares). If the share price stays above $80 there would be no incentive for Investor A to exercise the option (since they can sell for more on the market) and they would simply be out the $200 they paid to Investor B. If the price drops below $80 Investor A would have the incentive to buy shares of ABC Corp. on the market and then immediately sell them for $80 per share to Investor B by exercising the option. For example, if the price dropped to $70 during the time period Investor A could exercise their option and in total profit $800. $10 ($80 - $70) X 100 shares less the $200 paid to purchase the option. The risk to the seller of the option is that they may have to purchase the shares above the market price if the price drops below the exercise price.

So why would you want to sell a put option on a stock? If you are convinced of the long-term fundamentals of a company selling a put option allows you to get paid while you wait. Depending on the volatility of a stock the premium received can be very rich, but this also means a higher chance the option will be exercised. If you plan to purchase shares of a company on a pull-back then this strategy can make sense. Where you can get into trouble is if some sort of new information comes to light, and it is a company you are no longer willing to hang on to if the option gets exercised. This does sometimes happen and if the option hasn’t been exercised you do have the option of buying back your option from the market and covering your position.

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