Put and call options rarely are exercised in the stock market. Most option traders take the gains on the options if they have them or cut their losses short as early as possible if the market goes against them.
But if youre the holder of a put option and you decide to exercise it, youre selling the underlying stock at the striking price, and you can sell the stock at the strike price any time during the life of the option. If you write, or sell, the put, youre assigned the obligation of buying the stock at the strike price.
You can sell stock that you own at the strike price or buy stock in the open market if you dont own it, as in the case of a naked strategy, and then sell it at the strike price. You notify your broker how youll deliver or receive the stock. You must make sure that you can satisfy any margin or other requirement involved, and the exercise procedure and share transfer will be handled by the broker.Dealing with a huge profit in a put option
If youre lucky enough to get a nice drop in a stock on which you own a put option, you can do several things:
Do nothing.
Take profits. Doing so guarantees that you lock in a gain if you execute the trade in a timely manner.
Sell your in – the – money put and buy an out – of – the money put. By opting for this strategy, youre taking partial profits and then extending your risk and your profit potential if the stock continues to fall.
Create a spread strategy by selling an out – of – the – money put against the one you already own. This strategy adds an important new wrinkle to the possible strategies you can use. Your options:
Sell a different put option than the one you already own. You can, for instance, sell a December 45 put to offset the already profitable December 50 put that you own, all so that you make some money off the sale and lock in some of the costs of having bought the original December 50 put. If the stock goes above 50, you lose everything. But if the stock falls below 45 and stabilizes, you make the 5 – point maximum profit from the spread, which is the best of all worlds in this strategy.
Buy a call option. You can buy a December 45 call to limit your risk if the stock rises. See the previous sections about writing calls. Again your cost would be 5 points. This spread guarantees you 5 points no matter where the stock closes at expiration.
Spreads get the best results when the stock stabilizes in price after the spread is put on. But it is more important that the stock price stays in the profit range of the spread.
The IRS taxes short – term and long – term profits on every sale of every trade you make, except in a retirement account for which it taxes you later on, when you withdraw the money. Some tax – specific details you need to know if youre trading put options include the following:
Buying put options has no tax consequences if you re a long – term holder, usually greater than six months.
If you forfeit any accrued time during the holding period, or if youre a short – term holder of the stock and you buy a put option, holding time wont begin to accrue again until you sell the put, or it expires.
Be sure to consult with your accountant before you trade any options.
