Put to Seller Explained: Definition, Mechanism, and Practical Example

Thomas J Catalano is a Certified Financial Planner (CFP) and a Registered Investment Adviser in South Carolina. Since founding his own financial advisory firm in 2018, Thomas has developed expertise in investments, retirement planning, insurance, and comprehensive financial strategies.

What Does 'Put to Seller' Mean?

The term "put to seller" refers to the event when a put option is exercised, obligating the put writer to purchase the underlying shares from the put holder at the predetermined strike price. This occurs because owning a put option grants the holder the right to sell the underlying asset.

Typically, this situation arises when the strike price of the put option is higher than the current market price of the underlying security. In this case, the put buyer can choose to sell the shares to the option writer at the strike price, which is advantageous if the market price has decreased.

Key Points to Remember

• "Put to seller" happens when a put option is exercised by the holder.
• A put option gives the buyer the right, but not the obligation, to sell an asset at a fixed strike price before expiration.
• Upon exercise, the put writer must buy the underlying shares at the strike price from the put holder.
• The put writer's position is said to be "assigned" when this transaction occurs.
• Assignment usually happens when the option is in-the-money, meaning the strike price exceeds the current market value.

How Does 'Put to Seller' Work?

When the put buyer either holds the option until expiration or exercises it early, the put writer is required to purchase the underlying shares at the strike price. This obligation can result in losses if the market price has dropped significantly below the strike price.

While the maximum profit for the put writer is limited to the premium received for selling the option, the potential loss can be substantial if the underlying asset's price falls sharply.

Important Considerations

Understanding Put Options

A put option grants the holder the right to sell an asset at the strike price before the option expires. For example, if stock XYZ is trading at $26, and a trader buys a put option with a $25 strike price for a premium of $1.50, the option becomes valuable if XYZ's price drops below $25.

If the stock price falls to $24 or lower, the option holder may exercise the put, selling shares to the writer at $25. The break-even price for the holder is $23.50, which is the strike price minus the premium paid. If the stock price stays above $25, the option expires worthless, and the holder loses the premium paid.

Conversely, the put writer must buy the shares at the strike price if assigned, potentially facing significant losses if the market price is much lower. For each contract (representing 100 shares), this could mean a large cash outlay, offset only by the premium earned.

Key Insight

The maximum profit for the put seller is the premium received, while the potential losses can be much greater if the underlying asset's price declines.

Practical Example of 'Put to Seller'

Imagine an investor purchases put options on stock A, trading near $36, to protect against a price drop. They buy a three-month put with a $35 strike price for a $2 premium. The put writer earns this premium but assumes the risk of buying stock A at $35 if the price falls below that.

If, near expiration, stock A trades at $22, the put buyer exercises the option, selling the shares to the put writer at $35. This transaction is the classic example of a put being "put to the seller."

What Does Selling a Put Mean?

Put selling involves writing (selling) a put option. The seller collects the option premium upfront, aiming to profit if the underlying asset's price remains above the strike price and the option expires worthless. Put sellers benefit when the market rises or remains stable.

What Is a Naked Put?

A "naked put" occurs when an investor sells a put option without owning the underlying asset or holding an offsetting position. This strategy carries significant risk because if the underlying price falls sharply, the seller must still buy the shares at the strike price, potentially incurring large losses.

Do You Need to Own a Put to Sell It?

No. Selling a put option does not require owning the option beforehand. Unlike short selling stocks, which requires borrowing shares, selling puts involves creating a new contract with a buyer. However, if you already own a put option, you can sell it to close your position.

Why Choose Selling a Put Over Buying a Call?

Both buying a call and selling a put can profit from a rising underlying asset price. However, buying a call requires paying a premium upfront, while selling a put generates immediate income through the premium received. It's important to note that selling a put has limited profit potential (the premium) but significant risk, whereas buying a call has limited loss (premium paid) and theoretically unlimited gain.

Correction – October 8, 2022: Previous versions of this article incorrectly stated that selling a naked put has unlimited loss potential due to price increases. The risk is actually tied to price decreases, and the potential loss can be substantial but not unlimited.

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