What Is Put to Seller?
"Put to seller" describes the process of a put option being exercised. The put writer becomes responsible for receiving the underlying shares from the put buyer at the strike price, since being long puts gives the holder the right to sell the underlying asset.
Put to seller usually occurs when the strike price of the put is lower than the market value of the underlying security. At this point, the put buyer has the right, but not the obligation, to sell the underlying asset to the option writer at the strike price.
- Put to seller refers to the process of a put option being exercised.
- When a put option is exercised, the put writer receives the underlying shares from the long put holder at the strike price.
- A put option gives the holder the right, but not the obligation, to sell an asset at a predetermined price—the strike price—before the option expires.
Understanding Put to Seller
Put to seller occurs when a put buyer holds the contract to expiry or decides to exercise the put option. In both cases, the put writer is obligated to receive the underlying security that the put buyer has effectively sold at the strike price.
The profit on a short put position is limited to the premium received, but the risk can be significant. When writing a put, the writer is required to buy the underlying at the strike price. If the price of the underlying falls below the strike price, the put writer could face a significant loss.
If the option is exercised (often when it is deep in the money) and the writer needs to buy the shares, this will require an additional cash outlay. In this case, for every short put contract the trader will need to buy $2,500 worth of stock ($25 x 100 shares).
How a Put Option Works
A put option gives the holder the right, but not the obligation, to sell an asset at the strike price before the option expires. For example, stock XYZ is trading at $26. A trader buys a put option for $25 at a premium—or price—of $1.50. The option expires in three months. If the price of the XYZ drops below $25, that option is in the money and the option holder may choose to exercise the put option they purchased. The put option gives the investor the right to sell stock at $25, even though the stock may currently be trading at $24, $20, or even $1.
The option cost $1.50; the premium was $1.50. Therefore, the holder's breakeven price is $23.50. If the price of the stock remains above $25—and the three months pass—the option is worthless and the holder losses $1.50 per share. A single option contract represents 100 shares, so if the trader bought three options, they would lose $450, or 3 x 100 x $1.50 = $450.
On the flip side, the person who wrote the option has the obligation to sell shares at $25. If the price of the underlying drops to $10, they still need to sell the option holder shares at $25. In exchange for the risk that option writers take on, they get the premium the option buyer pays. The premium is the most an option writer can make.
Example of Put to Seller
Consider a situation where an investor buys put options to hedge downside risk in their position in stock A, which is currently trading near $36. The investor buys a three-month put on stock A, with a strike price of $35, and pays a premium of $2. The put writer, who earns the premium of $2, assumes the risk of buying stock A from the investor if it falls below $35.
Towards the end of the three-month period, if stock A is trading at $22, the long will exercise the puts and sell stock A to the put writer, and receive $35 for each share. In this case, the put option is exercised; in other words, it is put to the seller.