Investments, tenth edition

 Put Options 

 A put option is the right to sell an asset at 

the exercise price. In this case, the holder 

will not exercise the option unless the asset 

is worth  less  than the exercise price. For 

example, if FinCorp shares were to fall to 

$90, a put option with exercise price $100 

could be exercised to clear $10 for its holder. The holder would purchase a share for $90 

and simultaneously deliver it to the put option writer for the exercise price of $100. 

 The value of a put option at expiration is   

Payoff to put holder

5 b

0

if S

T

$ X

X

2 S

T

if S

T

, X

  

 The solid line in  Figure 20.4  illustrates the payoff at expiration to the holder of a put option 

on FinCorp stock with an exercise price of $100. If the stock price at expiration is above 

$100, the put has no value, as the right to sell the shares at $100 would not be exercised. 

Below a price of $100, the put value at expiration increases by $1 for each dollar the stock 

price falls. The dashed line in  Figure 20.4  is a graph of the put option owner’s profit at 

expiration, net of the initial cost of the put.  

 Writing puts  naked  (i.e., writing a put 

without an offsetting short position in the 

stock for hedging purposes) exposes the 

writer to losses if the market falls. Writ-

ing naked, deep-out-of-the-money puts 

was once considered an attractive way to 

generate income, as it was believed that 

as long as the market did not fall sharply 

before the option expiration, the option 

premium could be collected without the 

put holder ever exercising the option 

against the writer. Because only sharp 

drops in the market could result in losses 

to the put writer, the strategy was not 

viewed as overly risky. However, in the 

wake of the market crash of October 1987, 

such put writers suffered huge losses. Par-

ticipants now perceive much greater risk to 

this strategy. 

$30

S

T

80

90

100

110

120

Cost of Option

Profit

Payoff = Value at Expiration

−$14

−$10

0

$10

$20

 Figure 20.2 

Payoff and profit to call option at expiration  

$14

0

$100

$114

Profit

Payoff

S

T

 Figure 20.3 

Payoff and profit to call writers at expiration  

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