An option contract is a financial derivative that represents a holder who buys a contract sold by a writer. The moneyness of an option describes a situation that relates the strike price of a derivative to the price of the derivative’s underlying security. A put option can either be out of the money, at the money or in the money.
How Do Put Options Work?
A put option buyer has the right – but not the obligation – to sell a specified quantity of the underlying security at a predetermined strike price on or before its expiration date. On the other hand, the seller, or writer, of a put option is obligated to buy the underlying security at a predetermined strike price if the corresponding put option is exercised.
This is the opposite of a call option, which gives the option holder the right to buy an underlying security at a specified strike price, before expiration.
A put option should only be exercised if the underlying security is in the money.
When Is a Put Option ‘in the Money?’
A put option is in the money when the current market price of the underlying security is below the strike price of the put option. The put option is in the money because the put option holder has the right to sell the underlying security above its current market price. When there is a right to sell the underlying security above its current market price, then the right to sell has value equal to at least the amount of the sale price less the current market price.
The amount that a put option’s strike price is greater than the current underlying security’s price is known as intrinsic value because the put option is worth at least that amount.
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