A put option contract gives an investor the right to sell the underlying shares at a specified strike price before an expiration date. The percentage return of a put option depends on the difference between the current market price of the underlying shares and the strike price. It also depends on the market price of the options, known as the premium, at the time of purchase. A put option is in-the-money and potentially in a profit position if its strike price is more than the market price of the underlying shares; otherwise, it’s out-of-the-money and potentially in a loss position.
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Get the acquisition cost of the put option contracts from your trade confirmation records. This is equal to the product of the premium, the number of contracts and a contract multiplier. For equity options, the multiplier is 100, which means that one put option contract gives investors the right to sell 100 shares of the underlying stock at the specified strike price. For example, if you buy put option contracts of ABC stock at a premium of 50 cents per contract, your acquisition costs are $50 per contract — 50 cents multiplied by 100 — excluding brokerage commissions.
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Compute the break-even point, which is where you would neither make nor lose money. For put options, this point is equal to the strike price of the put option contract minus the premium. Continuing with the example, if the strike price is $20, the break-even point is $20 minus 50 cents, or $19.50.
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Calculate the profit, assuming the put option is in-the-money. The profit is equal to the product of the option multiplier and the difference between the break-even point and the stock price. In the example, if you decide to exercise the put options when ABC is trading at $18 per share, the profit is equal to $150 per contract — or 100 multiplied by ($19.50 minus $18). This formula assumes that you exercise the options, sell the shares short at the higher strike price and buy them back at the lower market price to make a profit. However, you may also sell the put option contracts prior to expiration, in which case the profit depends on the difference between the premium received and the premium paid.
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Compute the loss if the put options remain out-of-the-money at expiration or if you sell the contracts for a lower premium than your purchase price. If the options expire worthless, the loss is equal to the acquisition cost, which is $50 per contract in the example. If you sell the options at a price lower than your purchase price, the loss is equal to the difference in the two premiums.
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Calculate the percentage return, which is equal to the profit or loss divided by the acquisition cost. To close out the example, the percentage return is 300 percent, or 100 multiplied by $150 divided by $50. If the options expire worthless, the loss is 100 percent.
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