Question

Which of the following explains selling a put option?

1. You receive money
2. You pay money
3. You have the obligation to sell the underlying stock
4. Answers a and c
5. Answers b and c

Answer 1

a. You receive money

Under Put option an investor has the right but no obligation to sell the stock at exercise price.

How do Put options work?

Put options increase in value as a stock falls. That means put options are "In the money" when Spot price is less than the strike price. Having a put allows the owner to lock in a predetermined price to sell a specific stock, while put sellers agree to buy the stock at that price.

Let us understand with an example:-

Imagine stock ABC is trading at $100 per share. You can sell a put on the stock with a $100 strike price for $5 (premium) with an expiration in five months. One contract gives you $500, or (100 shares * 1 contract * $5). As a put seller, your gain is capped at the premium you receive upfront i.e. $500 in this case.

The advantage of selling puts is that you receive cash upfront and may not ever have to buy the stock at the strike price. If the stock goes above the strike by expiry date, you’ll make money. But you won’t be able to multiply your money as you would by buying puts.