Buying Index Puts

 

Index XYZ is below break-even point of 486 at expiration
 

Buy 1 XYZ 495 Put at $9

 
If index XYZ closes above the break-even point of 486 at expiration, at 480 for instance, the option will be in-the-money and worth its intrinsic value, (difference between the strike price and index level):

   $495   put strike price
   -480   XYZ index level
    $15    intrinsic value (cash settlement amount)

If you sell the XYZ 495 put for its intrinsic value of $15 then you would see a profit:

$15.00  intrinsic value received at put’s sale
-$9.00  premium initially paid for put
 $6.00  profit

This profit of $6.00 ($600 total) represents a return on an initial investment of $9 premium paid for the put ($900 total) of approximately 66.7% over the 3-month life of the put contract.

With XYZ at 480 at expiration, the in-the-money put could also be exercised. The exercise settlement value would be the closing index level of 480. The cash settlement amount would be: 495 (put strike price) – $480 (settlement value) = $15. The profit would be the same as if the put were sold for intrinsic value at expiration:

$15.00  settlement amount received at put’s exercise
-$9.00  premium initially paid for put
 $6.00  profit

 
 

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