What Happens When A Put Option Expires? The concept of buying and selling stock is easy to understand – it works like buying and selling anything else of value.
Those new to the stock market typically start with these types of trades. They attempt to acquire shares of promising companies when prices are low, then hold or sell as shares increase in value to generate returns.
The problem with buying stocks is that you must have cash on hand to make the purchase – and that’s not always practical. Powerhouse companies like Amazon (AMZN), Alphabet (GOOG), and Tesla (TSLA) are priced at more than $3,000, $2,000, and $700 respectively for a single share.
Other growing companies might be priced lower, but you must be able to buy a good number of shares to see meaningful returns.
Some choose to take their investing to the next level: buying and selling options. Options require more sophisticated strategies, but they can generate substantial returns without the same initial outlay of cash.
Options are contracts that give the options buyer or the options holder the right to buy or sell a certain number of shares at a predetermined price within an agreed-upon period of time.
In addition to the potential value of the underlying stock, the options contracts themselves hold value. Those who buy options pay a premium to sellers for the rights granted by the contract, and the options seller keeps the premium no matter what the underlying stock does.
What Is A Put Option?
Put options are contracts that allow the holder – the person who buys the option – the right to sell 100 shares of an underlying stock at an agreed-upon price known as the strike price.
The put option is written for a finite amount of time, through the expiration date. Note that those who hold put options aren’t required to sell the underlying stock at any point. They can sell the option to another investor before the expiration date, or they can allow it to expire with no action.
Those who write put options – the ones who sell the options – take on the risk that the holder will exercise the contract. If put options are exercised, the writer must buy the underlying shares from the holder at the strike price named in the contract.
Whether the put option is exercised or not, the writer collects and keeps the premium charged for taking on the risk associated with the contract.
What Happens When a Put Option Expires: For Those Buying/Holding Put Options
Beginning a trade by purchasing a put option (buy to open) is a strategy generally used by those who believe the price of the underlying stock will go down. This is referred to as a long put strategy.
If the price of the underlying stock does go down, the put becomes more valuable and can be sold at a higher premium, or the holder can sell shares at a price that is higher than market value.
If you bought a put option, there are two possible scenarios you will face as the expiration date approaches. First, the share price is higher than the put option strike price. That means the option is “out-of-the-money” or OTM, and it expires worthless. Your loss is limited to 100 percent of the premium you paid for the option.
The second scenario is that the share price is lower than the put option strike price. In other words, the options contract is “in-the-money” or ITM. Your profit is the difference between the strike price and the market price of the underlying shares, less the premium you paid for the contract.
For example, if the price of ABC company is $50 per share, and you expect that to drop, you might purchase a put option with a strike price of $45 per share. At expiration, the market price has dropped to $40 per share. If you paid $1 per share for the put, then your profit is the $5 difference between strike price and share price less the additional $1 per share premium. Since put options are written for 100 shares, the final result would be $500 – $100 or $400 profit per contract.
Keep in mind that your brokerage may have standard practices for handling your expiring options. One of the most common is to automatically exercise put options if the share price is below the strike price at expiration. The benefit of this practice is that you don’t risk losing the opportunity to exercise your ITM options before they expire.
However, there is a downside. The automatic conversion may result in a short position after your put option expires. This is a situation you should address immediately, as short positions carry virtually unlimited risk.
If you aren’t able to keep a close eye on your options, it may be best to turn off this automatic conversion feature in your brokerage account or otherwise notify your broker that you prefer to handle expiring options another way.
What Happens When a Put Option Expires: For Those Writing/Selling Put Options
Beginning a trade by selling a put option (sell to open) is a strategy used by those who are confident that the underlying stock will stay above the strike price of the put option. If that prediction is accurate, selling a put option generates profits through contract premiums.
If you sold a put option, there are two possible scenarios you will face when the option expires. First, if the price of the underlying shares is higher than the put option strike price, the option expires OTM. You keep the premium you received when you sold the contract, and the option expires with no value.
The second possibility is that the price of the underlying shares has decreased, and the put option you sold is ITM when it expires. The put option is automatically assigned, and you must buy the stock at the strike price listed on the contract. However, you keep the premium you charged when you sold the option, so that decreases the total amount of your loss.
Consider this example. ABC company’s stock was trading at $50 per share when you opened a short put position with a strike price of $45. By the time the put reaches its expiration date, the stock is down to $40 per share.
You still have to buy the shares at $45 each, but you make up some of the difference with the $1 per share premium you received at the time of the sale. With a contract for 100 shares, your results would look something like this: $500 – $100 or $400 loss per contract.
Other Put Strategies
As you grow comfortable with buying and selling puts, you may consider more sophisticated strategies. Experienced investors work to generate profits through options strategies like married puts, bear put spreads, protective collars, long straddles, long strangles, and so forth.
The more complex the options strategy, the greater the risk – you can find yourself on the hook for unexpected losses. In most cases, these complex options strategies are best left to experienced and professional investors.
The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.