A put option is a contract between two parties (a buyer and a seller) whereby the buyer acquires the right but not the obligation to sell a specified stock or other underlying instrument at a specified price by a specified date.

A put option is a contract between two parties (a buyer and a seller) whereby the buyer acquires the right but not the obligation to sell a specified stock or other underlying instrument at a specified price by a specified date.

The premium of a stock option depends partly on its relation to the underlying stock. This is signified by the option’s strike price as related to the market price of the stock at the time of the option purchase. If the strike price of the option is equal to the current market price, the option is considered at the money. You buy an out-of-the-money option because you believe that given the volatility of the shares and the time you are guaranteed …

The seller of a put option assumes the obligation of taking the surrender of the stock or other underlying instrument from the buyer should the buyer wish to exercise his option. The put is known as a short instrument which implies that the buyer profits from the stock going down.

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This is because the stock has to trade down below the strike plus the price of the option. If the stock traded down to $60.00, you would make $5.00 Because you have the right to sell it at $65.00. However, because you paid $2.00 For the put, you must subtract that from your $5.00 Profit, making a total profit of $3.00. You have just made $3.00 On a $2.00 Investment. Not a bad return.

How is the time value of an options premium calculated?

Options premium price = intrinsic value + time value Time value = premium price – intrinsic value I know that intrinsic value is the amount the option is in the money i.e. a stock price of $80 on a $70 call would lead to an intrinsic value of $10 (and the time value is added onto this to get the premium). But how exactly is the time value itself calculated, i.e. is there any special algorithms or formulas for this? Thank you for all answers, Ben

What you are talking about is the "Extrinsic Value" of an option which is calculated using the Black-Scholes Model. Read more about it in the tutorial below.

If the car costs $20, 000 and the residual is $12, 000, what about the other $8, 000? That’s considered a loan, and any banker (call one up and ask one……or use the Internet) will tell you from his little book that to repay an $8, 000 loan in 36 monthly payments will cost $236.19/month.

The buyer of the put has limited risk and unlimited potential gain. His risk is limited solely to the amount of money he spent in purchasing the put. His unlimited potential gain came from the stocks unlimited downside potential.

The seller, on the other hand, has limited potential gain and unlimited potential loss. The seller can only gain what he was pay for the put. The unlimited risk came from the stock price’s capacity to decline during the term of the contract.

If MSFT declines and trades down to $55.00, the seller would realize a $10.00 Loss less the amount he received under the sale of the option ($2.00), for a net loss of $8.00. Meanwhile, the buyer would realize a $10.00 Profit less the amount he pay for the option ($2.00), for a net gain of $8.00 per contract.

For example, if a seller sold the MSFT January 65 put for $2.00, he is giving the buyer the right to sell 100 shares (per contract) of MSFT to him at $65.00 per share at any time until the option expires.

If MSFT were to trade up to $75.00, the seller would realize a $2.00 Profit (the amount of money he was paid from the buyer). Meanwhile, the buyer would only lose what he pay for the option ($2.00). The seller is required to take the surrender of the stock from the buyer at the strike price regardless of the current market price of the stock. This is why the seller receives premium for the sale.

Again, the following graphs are called parity graphs. They are intended to show you your option’s profit and loss at expiration (when they’re trading at parity: I.e. when they’re trading without intrinsic value). The first graph shows a put purchase and the second shows a put sale. The graphs show the amount of your expenditure (in the case of a purchase) or the amount you have received (in the case of a sale) and the dollar price of the stock where you would breakeven.

Using the fictitious stock XYZ below, make note of the place where the stock has to be at expiration in order for you to be profitable, and how the premium paid (in the case of a purchase) or the premium received (in the case of a sale) affects your profitability. Also notice the difference in the profit potential between a purchase of the option as opposed to a sale of the option. Lastly, it is important to emphasize the unlimited potential risk inherent in the sale of an option, compared to the fixed risk of an option purchase.