
Question By Abiola Abdullah
"Does My OTM Put Profit Before Strike Price Is Reached?"
If I buy out of the money (OTM) put options and the stock is moving towards my strike price, do I still make money prior to it going below said strike price? ex: stike price is $11, current stock price $11.54 (I paid 54 cents per share), price drops to $11.10 in the trading day. Does my portfolio reflect a gain or does the stock have to drop below the strike price of $11?
Asked on 1 June 2011

Answered by Mr. OppiE
Hi Abiola,
The profit or loss of all options positions may be viewed in two primary ways; Short term movement based on its greeks and expiration value.
Anytime before expiration, the price of options positions move based on their greeks. For example, an options position with positive delta increases in value as the price of the underlying stock increases and an options position with negative delta would increase in value as the price of the stock decreases. An options position with positive vega would also increase in value as implied volatility rises and decrease in value as implied volatility drops. Implied volatility affects options with longer expiration more than near term options. For near term options, it is primarily the delta value that governs the price change.
The expiration value of an options position is the end value of an options position upon expiration and is usually what options traders calculate before putting on a position. This gives you the maximum profit or loss of an options position and which is realised only upon expiration.
Buying put options gives you negative delta. This means that in the short term, the put options would increase in value according to its delta value as the price of the underlying stock falls. Buying put options also gives you positive vega. This means that in the short term, the put options would increase in value as implied volatility rises as well. However, upon expiration, the put options would only profit in the amount of the difference between the stock price and the strike price. If the stock fails to go below the strike price of the put options by expiration, whatever value it gained due to delta and vega before expiration will eventually evaporate due to time decay.
Does My OTM Put Profit Before Strike Price Is Reached?
Assuming the following parameter:
Initial Price of Stock = $11.54, Price of Puts = $0.54, Delta of Puts = 0.4.
If price of stock drops to $11.10 the very day, the value of your put options should increase by:
$11.54  $11.10 = $0.44 x 0.4 = $0.176
$0.54 + $0.176 = $0.716
If the price of the stock drops to $9 by expiration, the value of your put options would be:
$11  $9 = $2
However, if the price of the stock remains above $11 by expiration, the whole value of $0.716 would decline to zero and expire worthless.

The above calculation only serves to give you an idea of how much your put options will gain given that kind of move on the underlying stock. In reality, the amount may be more or lesser than calculated due to many other factors such as demand for the options contract traded or other factors such as volatility crunch.
In conclusion, yes, the price of the stock need not go below the strike price of your put options in order to produce a profit in the short term. However, going below the strike price is imperative in order to produce a profit by expiration otherwise the put options would just expire worthless.

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Response by Abiola...
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