Special Considerations for Put Options
One way to lock in a total (strike) price for an asset is by purchasing a put option. The holder of the contract has the right, but not the obligation, to sell the asset at that strike price before expiration. When an option expires, it is settled. Options can be worth either nothing or something at the time of exercise. The underlying asset's price will affect the option (as well as its time value).
When calculating the time value, subtract the option's intrinsic value from the premium. The basic formula is as follows:
Time Value = Option Premium − Option′s Intrinsic Value
Investors are often willing to pay more for options because they believe that the value of the option will increase. The amount you're willing to pay for an option depends on how much time is remaining until it expires. The intrinsic value of an option is calculated by multiplying the option's strike price by the input interest rate. For example, let's say that an out of the money call has a $50 strike price and a 2% input interest rate. That would give us 100 * 2 = ($100) = ($100) = $2 intrinsic value. For example, you would want the premium to be higher than the option's intrinsic value. If not, you'll end up losing on your purchase.
What Is An Example of an In-The-Money (ITM) Put Option (Example from Investopedia.com)
Here's a hypothetical example to show how put options work when they're in the money. Assume that you have a put option for shares in Company XYZ. This contract gives you the right to sell 100 shares of the company at a strike price of $100. And you purchased the put option at a premium of $10 with the belief that the stock price would drop before the expiration date.
Your hunch proves to be right at the expiration date and the stock price dips to $75 per share, rendering the put option in the money. You could exercise the option and net yourself a profit of $15 per share, which is the difference between the strike price and the actual price of the stock and the premium you paid ($25 - $10). If you multiply that by the number of shares (100), then you get a profit of $1,500.
