I’m a little confused on how options work in application. For example, say you buy a put on stock xyz, with strike 7.50, expires in November. The underlying stock is at 10, and the put costs .30, so, $30 for one contract. What happens if the stock goes down to 8? The put option price will increase, say 0.50, but the stock still is not lower than the strike of 7.50. Can you sell your put option for 0.50, or $50? Would this close out your position, or are you now “short put”? Would the same concept apply if your position moved against you (e.g. the underlying went up, and your put is now near worthless and far out of the money, .10, can you sell for the $10)? Looking at the graphs, they seem to figure that you hold until expiry, but if you can make a profit before then by selling the contract and closing out your position, then the graph doesn’t seem to take that into account.
If you buy a 7.50 put for .30 when the underlying is 10…you are long a put…If underlying goes down to 8…your put will be worth more as it approaches the strike. The increase in value of the put will depend on the time to expiration. if you sell your put at 0.50 vs 0.30 purchase…you will close out your position. short + equal size long = Flat! If you hold until expiration, and exercise is 7.50 with underlying trading at 8,put will be worthless…why exercise to sell at 7.50 when you would have to buy back at 8 ? If 8 is trading 2 months before the 7.50 strike,the time value would make the option worth more than the .50 for example. If stock goes to 10…would you exercise your chance to sell at 7.50 and take a loss of 2.50 and the cost of your put…or just let it expire and suffer the smaller loss of what you paid for the put…you were paying for the opportunity, which didn’t appear to work out in that case. Any clearer?
perdition Wrote: ------------------------------------------------------- > if you sell your put at 0.50 vs 0.30 > purchase…you will close out your position. short > + equal size long = Flat! Ok, that does make sense. > If you hold until expiration, and exercise is 7.50 > with underlying trading at 8,put will be > worthless…why exercise to sell at 7.50 when you > would have to buy back at 8 ? Yeah, I see what you’re saying. I just didn’t know if it was possible to close out your position by selling the contract before expiry, even though it’s out of the money. If you don’t believe the underlying will go below 7.50 by expiry, then it will be worthless, and it would have been better to sell when the option was at 8 and still had value. > If 8 is trading 2 months before the 7.50 > strike,the time value would make the option > worth more than the .50 for example. > > If stock goes to 10…would you exercise your > chance to sell at 7.50 and take a loss of 2.50 and > the cost of your put…or just let it expire and > suffer the smaller loss of what you paid for the > put…you were paying for the opportunity, which > didn’t appear to work out in that case. > Any clearer? Hmm, I’m still a little unclear. If it went to 10, and option was near worthless (say, .10), even though there is still time for the stock to go back down and the option to gain value, say you want to get that $10, and reduce your loss of initially paying .30? In this scenario, you paid a premium of .30, or $30, now the stock has went up, the put is worth only .10, if you sell at that price, you get $10, and ultimately lost $20; you give up the possibility the stock goes down and put value increases, but, if expiry is coming up soon, isn’t it better to get something, that is, if it’s possible to close out your position in this manner?
Exactly…an option will be worth something depending on proximity and time to strike… Go to CBOT to site, there are options of Tnotes or CME for euro$… Say stock is trading 15…with a week to expire with a strike at 5…you often see these options trading at cabinet or 0.5 (lowest trade denomination) If you are long you either hold until expire, lose all the premium you paid or maybe sell at 0.5 to recover some of the trading cost for example…you are then flat. the danger comes where you establish a short, selling these small premiums, in the hope that it is unlikely you will lose and the option will expire at 0… This has been likened to picking up coins in front of a bulldozer, if the underlying does trade down…the put you sold outright for peanuts,may be worth considerably more,you may have to pay a multiple of the premium you picked up on the sale to cover your position.
“Hmm, I’m still a little unclear. If it went to 10, and option was near worthless (say, .10), even though there is still time for the stock to go back down and the option to gain value, say you want to get that $10, and reduce your loss of initially paying .30? In this scenario, you paid a premium of .30, or $30, now the stock has went up, the put is worth only .10, if you sell at that price, you get $10, and ultimately lost $20; you give up the possibility the stock goes down and put value increases, but, if expiry is coming up soon, isn’t it better to get something, that is, if it’s possible to close out your position in this manner?” Theoretically it is possible for you to do this. However, the price wouldn’t be worth $10 in real life, as a lot of an option’s value is derive from time. Thus the transactions costs of selling the put would probably outweigh the gains from doing so, and you’d let it expire.