Example of a put option
Let’s say that you thought that the share price of company ABC was going to fall from its current price of £30, and so you decide to open a put option with a strike price of £25. For stock options, each contract is worth the equivalent of 100 shares, but the price is usually quoted for one share.
When dealing options, there is always a premium to be paid. If the premium of this option was £1 per share, your total premium is £100.
If the price of ABC stock did fall, to a market price of £20, you could execute your right to sell the stock for the agreed strike price of £25 a share.
To calculate the profit, you subtract the market price from the strike price, giving you a profit of $5 per share. Since put options come in lots of 100 shares, you multiply that £5 per share profit by 100, which yields a gross profit of £500. After deducting the £100 premium, you would be left with a net profit of £400.
However, if the market had moved against you, you could let the option expire and your maximum loss would be cost of the initial £100 premium.