The Sale of Put Options




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Mr. B. sells a Put option on each stock at 50 for 90 days for $300 premium for each 100-share Put. He has received $3,000. At the expiration of the options, no Puts are exercised, and he has earned $3,000 on his possible investment of $50,000 of cash he is holding for investment, at an annual rate of about 24 per cent.

An individual (or a company) has $100,000, which he would invest in common stocks. He could buy these stocks in the market or he could sell Put options in an attempt to acquire the stocks a few points below the current market price or to earn premiums from the sale of Put options against the money that he is willing to invest.

For an example: With a stock selling at 50, a man (or a company) sells a Put option at 50 for 90 days, receiving a premium of $300 for each 100-share Put contract. For the $300-premium, which he receives at the time that he "makes" the Put contract, he agrees to buy 100 shares at 50 before expiration of the option if the holder of the option cares to deliver it to him. The maker of the Put has no choice—he must receive and pay for the stock if it is Put to him. The option is with the holder of the contract. If, before or at the expiration of the option the holder of the contract cares to deliver the stock, the maker of the option must buy 100 shares at 50, which price is reduced by the $300 he received for the option, making the cost to him 47. If the stock is above the Put price, the holder of the Put option will not deliver stock and the writer or maker of the option has benefited by the $300 received for the contract. Here, too, it must be remembered that if it is possible to sell four such Put options in a year (there are four 90-day periods in a year), the annual return will be $1,200 on a possible investment of $5,000.

The operation can be worked on a number of shares of stock or stocks up to the point where the total amount to be paid for the stocks (if the holders of the Puts exercise them), less the premiums received, equals the amount of cash held for investment. To illustrate:

Suppose that Mr. A. and Mr. B. would each like to acquire 1,000 shares of different stocks selling at 50. Mr. A. buys 1,000 shares:

100 A at 50 $5,000
100 B at 50 5,000
100 C at 50 5,000
100 D at 50 5,000
100 E at 50 5,000
100 F at 50 5,000
100 G at 50 5,000
100 H at 50 5,000
100 I at 50 5,000
100 J at 50 5,000
Total Cost $50,000

Mr. B. sells a Put option on each stock at 50 for 90 days for $300 premium for each 100-share Put. He has received $3,000. At the expiration of the options, no Puts are exercised, and he has earned $3,000 on his possible investment of $50,000 of cash he is holding for investment, at an annual rate of about 24 per cent.

If the Put options are exercised, he will have an account such as this:

Bought 100 A on a/c of Put $5,000
Bought 100 A on a/c of Put 5,000
Bought 100 A on a/c of Put 5,000
Bought 100 A on a/c of Put 5,000
Bought 100 A on a/c of Put 5,000
Bought 100 A on a/c of Put 5,000
Bought 100 A on a/c of Put 5,000
Bought 100 A on a/c of Put 5,000
Bought 100 A on a/c of Put 5,000
Bought 100 A on a/c of Put 5,000
Total Cost $50,000
Less Premiums Received 3,000
Net Cost $47,000

Mr. A's list cost him $50,000, while Mr. B. has acquired the same stocks at a cost of $47,000. It isn't likely that the situation would work out this all-or-none way; probably some Puts would be exercised, some not. But the principle is clear.

So much for selling a Put or Call option. A man sells a Put option if he is willing to have the stock delivered to him. He may be short the stock and willing to cover, or he may have no position in the stock but have funds to pay for the stock and be willing, for a premium, to acquire the stock at a price which may be above the market price for it at the time the Put option is exercised by the holder.

Conversely, if a man owns stock which he would be willing to sell, he sells Call options,and the premium which he receives enhances the selling price if the Call is exercised; if it is not exercised, the premium adds to the income on the stock which he holds.

Buy 100 Shares and Sell Straddle or Buy 200 Shares

Consider the difference, if you will, between these two methods: Mr. A. is bullish on XYZ and buys 200 shares at the market, which is 70. Mr. B. is also bullish and buys 100 shares at 70, and at the same time sells a Straddle at 70 for 90 days for $700. At or before the time the option expires, one of three things will happen:

(1) At the expiration of the contract (neither side having been exercised prior to that date), the market price for the stock is just about the Straddle price. This rarely happens, but it can and sometimes does.

Neither the Put nor the Call is exercised and Mr. B. has gained the $700 premium.

(2) The stock is selling below 70, the Put price, and Mr. B. will have 100 shares delivered to him on the Put option, which will make his position as follows:

Bought 100 shares in market at 70 $7,000
Had 100 shares Put at 70 7,000
Net Cost $14,000
Less premium received 700
Net Cost of 200 Shares $13,300
or 66½ for each 100 shares

(3) The stock is above the Call price (70) and Mr. B. will have his 100 shares called from him at 70. His account will look like this:

Sold 100 shares (through Call) at 70 $7,000
Sold Straddle 100 shares—premium 700
$7,700
Bought 100 shares in market at 70 $7,000
Profit $ 700

The first situation needs no discussion as it rarely happens. If it does, however, Mr. B. is at liberty to sell another Straddle, having profited by the premium of $700 on an actual investment of $7,000 and a possible investment of $7,000 on the outstanding Put option—or at the rate of 20 per cent per annum.

In the second situation the market is down, but Mr. B. has his 200 shares at a cost of $13,300, whereas Mr. A. has his 200 shares at a cost of $14,000.

In the third situation, we know that Mr. B. made $700.

What Mr. A. made is problematical; it depends on what he did with his stock. If he sold his stock in the market below 73½, he did not do as well as Mr. B.; if he sold it above 73½, he did better than Mr. B. Mr. B.'s method of operation is quite mechanical—each 100 shares of stock he holds is a unit on which he tries to earn as many premiums a year as he can. Each $7,000 he had available for investment is also considered a unit which can earn him a premium, and on this, too, he tries to earn as many premiums as he can each year. Mr. B.'s only problem is to stay in and sell options on stocks which he would be willing to have in his investment portfolio if the Puts are exercised.

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