Buying a put contract on a stock gives you the chance to make a large profit if the share price of that stock takes a dive. Puts give you the chance to turn a few hundred dollars or less into hundreds, possibly thousands more, if you guess right on the stock price. However, all option contracts, including puts, have an expiration date -- and you may need to take some action before your put expires.
Anatomy of a Put
A put contract gives the put buyer the right to sell 100 shares of the underlying stock at a preset price. The seller of the put must buy the share if the buyer chooses to exercise the contract. The defining features of a put are the specific stock, the exercise price (called the strike price) and the expiration date. Expiration comes on the third Friday of the listed expiration month. Since a put covers 100 shares, the cost will be 100 times the quoted price. So if you see a put quoted at $3.50, it would cost $350 plus commission to buy one contract.
Underlying Stock Price
The value of a put depends on the relationship between the put's strike price and the underlying stock price. If the stock share price is below the strike price, the put has intrinsic or real value. You could buy the shares and then exercise the put to deliver the shares to receive the higher exercise price of the option, locking in a profit. If the stock price is above the put strike price, the put has no intrinsic value. The contract may have a market value, however, depending on how much time remains until it expires.
When your put reaches the expiration date, what happens then depends on the stock to exercise price relationship. If the stock is above the strike price the put expires without value and any money you paid for the contract is lost. If the stock is below the strike price, the put will be automatically exercised over the weekend. An exercise means that you must deliver 100 shares of the underlying stock. If you don't own the stock, your brokerage firm will go into the market and buy the shares to deliver as per the put requirement. With any automatic exercise, you need to have enough cash or margin credit in your account to cover the transaction.
Get Out Before Expiration
If you own a put with intrinsic value on expiration Friday, you probably don't want to let it expire and go to automatic exercise. You just place an order to sell the put, and you'll receive the same value as if you bought the shares and went through the exercise process. Selling the put also results in a much smaller amount of commissions to your broker. You can sell a put you own at any time to lock in a profit. The put's value always reflects any decline in the stock price.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.