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Lesson 6. Stock Derivatives > Options - Pg. 32

Stock Derivatives 32 Ownership Not Required Like the call, you don't actually have to own the underlying stock in order to make money from a put option. Let's say for example, that XYZ Company stock is selling for $10 per share. You believe that the price of XYZ Company will drop. It certainly doesn't make sense to purchase stock in a company with shares you believe will drop in value. Through the use of a put, however, you can still make a profit from this situation. Since you believe the price of XYZ Company stock will drop, you consider purchasing 10 put options at $1 per option. This would cost you $10. Then the price does in fact drop to $6 per share. But you didn't actually purchase any shares of XYZ stock, so you have no stock with which to exercise the option. No matter; you find another investor who does own 10 shares of XYZ Company stock and is looking to get rid of them. You sell him or her your options for $2 each--the dollar you paid and a dollar profit on each put. You have just made $10 from your initial $10 investment, so you are ahead 100 percent. The buyer of your options sells his or her shares at $9 each for a total of $90; after subtracting the $20 paid to you for the options, the buyer's total is $70. Not a great day by any means but still $10 better than having sold the shares at $6 per share for a total of $60. On the other side, if you were the seller of the options, you could make a quick and easy $10 from selling the put. For the record, the put price of an option is also known as its premium. Should the price of XYZ Company stock never go up, or at least stay the same, the put owner would never exercise his or her option; and upon the expiration date, you would be $10 richer for doing absolutely nothing more than making a promise on which you never had to make good. Before you get too excited and start selling puts, be aware that you would be responsible for pur- chasing the stock from the put holder on demand, regardless of what the price on the open market is. Whether or not you own stock in this case is irrelevant, because if the price of XYZ Company stock drops to $1 per share you are still required to purchase the put holder's shares for $10 per