Question

1. Susan sells a put to Peter on 6/1/20 and Susan agrees to purchase up to 1,000 shares of Microsoft stock from Peter at $90 per share anytime on or before 11/1/20. Peter had purchased the shares 9 months earlier for $100 per share. Microsoft is selling for $100 per share on 6/1/20. Peter pays Susan $10,000 for writing the put. The stock never falls below $95 per share and the put lapses without being exercised. How do Susan and Peter treat the writing of the put and its later lapse?
2. Same as except the price of Microsoft falls to $85 and Peter exercises the put. Susan agrees to pay Peter $5 per share ($5,000) to settle the put.

Answer 1

1. Susan sells a put to Peter on 6/1/20 and Susan agrees to purchase up to 1,000 shares of Microsoft stock from Peter at $90 per share anytime on or before 11/1/20. Peter had purchased the shares 9 months earlier for $100 per share. Microsoft is selling for $100 per share on 6/1/20. Peter pays Susan $10,000 for writing the put. The stock never falls below $95 per share and the put lapses without being exercised. How do Susan and Peter treat the writing of the put and its later lapse?

Susan gets to keep the entire premium of $10,000 for writing the option. Peter loses his entire premium because the put option expired worthless. Peter gets to keep his 1,000 shares at the current market price and he may be happy because the price didn't fall significantly. By keeping his shares he has opened up the opportunity for the upside potential of the stock.

2. Same as except the price of Microsoft falls to $85 and Peter exercises the put. Susan agrees to pay Peter $5 per share ($5,000) to settle the put.

This settlement is known as the cash settlement. Instead of Susan purchasing the stock at $90 from peter and then selling it in the market for $85. Susan agrees to pay Peter the difference amount. Peter still has his shares and has gained $5,000 but he his shares are worth $85