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"Exercising Put Options Without Assets?"

Question By RB

"Exercising Put Options Without Assets?"

What will I receive if I exercise a long put and I have no assets?

Asked on 15 June 2010

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Answered by Mr. OppiE

Hi RB,

First of all, I shall assume that you are exercising in the money put options as there is no point at all exercising out of the money put options neither would out of the money put options be subject to early assignment or automatic exercise upon expiration.

Put options grants you the rights to SELL the underlying asset at the strike price anytime up to expiration. This effectively allows you to secure a selling price for stocks that you own so that your stocks will never fall below the strike price of the put options bought. This is known as a Protective Put options trading strategy. As such, you are right to be concerned about what happens if you bought put options without owning the underlying stock in the first place and then either exercise it volunteerily when it is in the money or automatically assigned by your broker.

When you exercise put options without first owning the underlying stock, you will still be selling the underlying stock except that now you are selling SHORT. This means that you will end up owning a short position in the underlying stock. A short stock position happens when you sold stocks BORROWED from your broker first with the intention of buying back the stocks at a lower price, reaping the price difference as profit, and then returning the shares to your broker. For instance, if you own 1 contract of QQQQ's $50 strike price put options when QQQQ is at $44, you will end up with short 100 shares of QQQQ at the price of $50.

However, this happens only when you have enough funds in your trading account to fulfill the margin requirements of holding those short stock positions in the first place. Yes, shorting stocks requires margin and most brokers require a cash reserve of at least 50% of the value of the stocks that are shorted. As such, if you do not have enough cash to hold on to the short stock position, your broker would usually liquidate the position and pay you the net returns when your put options are exercised.

In conclusion, if you are holding a profitable put options position and you think the underlying stock could still be going lower and wants to ride the profits by exercising the put options and holding on to the short stock position, you would need to make sure that you have enough cash in your account to meet margin requirements, otherwise, exercising your put options would only return you your net profit in cash after exercise.

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