How to Close a Put Option: Methods and Steps

A put option is a financial contract giving the holder the right, but not the obligation, to sell an underlying asset at a predetermined strike price on or before a specified expiration date. Each contract typically represents 100 shares. Investors acquire put options to speculate on price declines or protect existing investments. Closing an options position allows investors to realize gains or losses without waiting for expiration, effectively reversing the initial transaction.

Understanding Closing Methods

Investors holding a put option have several methods to close the position, each with distinct mechanics. These methods offer flexibility to lock in profits, limit losses, or exit the trade. The choice depends on the option’s profitability, time remaining until expiration, and the investor’s market outlook.

Selling to Close

Selling to close involves placing an offsetting sell order for the identical put option contract that was initially purchased. This action cancels the existing long put position. For example, if an investor bought one put option contract, they would sell one contract of the same option to close the position. This method is the most common way to realize profit or loss from a put option before its expiration.

This strategy is particularly suitable when the put option has increased in value due to a decline in the underlying asset’s price, or if the investor anticipates a reversal in the asset’s price movement. The primary benefit of selling to close is that it allows the investor to capture the option’s current market value, which includes both intrinsic and extrinsic value, without engaging in the physical delivery of shares. The premium received from selling to close, minus the premium originally paid, determines the profit or loss.

Exercising the Option

Exercising a put option means utilizing the right to sell the underlying asset at the specified strike price. This action requires the investor to deliver 100 shares of the underlying security for each contract exercised. If the investor does not already own these shares, they would need to purchase them at the current market price before they can be sold at the option’s strike price.

Exercising is generally undertaken when the put option is “in the money,” meaning the underlying asset’s market price is below the option’s strike price. For example, if a put option has a strike price of $50 and the underlying stock is trading at $40, exercising allows the holder to sell shares at $50, which is higher than the current market price. This method is often chosen when the option is deep in the money and nearing expiration, particularly if the investor wishes to exit a stock position at a favorable price.

Physical and cash-settled options differ. Most equity and ETF options are physically settled, requiring share delivery upon exercise. Index options and futures contracts are cash-settled, meaning a cash equivalent is exchanged. For cash-settled options, the investor receives or pays the difference between the strike price and the underlying asset’s value in cash.

Allowing Expiration

Allowing a put option to expire means taking no action as the expiration date passes. If the option expires “out of the money,” meaning the underlying asset’s price is above the strike price, the option will become worthless. In this scenario, the investor’s maximum loss is limited to the premium originally paid for the option.

This method is chosen when the put option has lost all its value or when selling to close would outweigh any remaining value. If an option expires in the money, most brokerages automatically exercise it, converting it into shares or a cash settlement, unless a “Do Not Exercise” request is submitted. Investors must be aware of their option’s status as expiration approaches to avoid unintended outcomes.

Executing the Closing Transaction

Closing a put option position involves specific steps on a brokerage platform, whether selling to close or exercising. The process typically begins by accessing the trading interface and locating the relevant options contract.

Steps for Selling to Close

To sell to close a put option, an investor first navigates to their brokerage account’s options positions page. From there, the specific put option contract intended for closure is selected. The platform will usually present an option to “Sell to Close” or a similar designation, which initiates the order process.

Specify the number of contracts to sell. Choose an order type, typically a limit order or a market order. A limit order sets a specific price, ensuring a desired execution price but potentially delaying the fill. A market order executes immediately at the best available price, offering certainty but not necessarily the best price. After confirming details like option symbol, expiration, strike, and quantity, submit the order.

Steps for Exercising the Option

Exercising a put option requires a more direct interaction with the brokerage, as it results in a transaction involving the underlying shares. Investors typically locate their put option position within their account and look for an “Exercise” or “Assignment” function. This function might be found within the details of the specific option contract or through a dedicated options action menu.

Upon selecting exercise, the platform prompts for confirmation, outlining implications like selling 100 shares per contract at the strike price. Confirm share ownership or ability to acquire them if not held. Some brokerages may initiate a “sell short” or require a separate stock purchase. After confirming, the transaction processes, and the resulting stock position or cash settlement reflects in the account within one to three business days.

Key Considerations Before Closing

Before deciding on a closing method, several financial and timing considerations warrant evaluation. These factors influence the transaction’s potential profitability and outcome.

Profit and Loss Scenarios

Evaluating potential profit or loss is a primary consideration. The underlying asset’s current market price relative to the strike price determines intrinsic value. A put option profits when the underlying asset’s price falls below the strike price. For example, if a put with a $50 strike was bought for a $3.00 premium and the stock trades at $40, the option has $10.00 intrinsic value. If sold, the profit would be $7.00 per share, or $700 per contract ([$10.00 intrinsic value – $3.00 premium] x 100 shares).

Conversely, if the underlying asset’s price rises above the strike, the put option may lose value. If out of the money, selling to close might recover some extrinsic value, while allowing it to expire worthless results in a loss of the entire premium. When exercising, profit or loss is determined by the difference between the strike price and the shares’ cost basis, adjusted for the option premium. Gains or losses from options are generally treated as capital gains or losses for tax purposes. Short-term gains are taxed at ordinary income rates, while long-term gains may qualify for lower rates.

Time to Expiration

The remaining time until an option’s expiration date significantly impacts its value due to a phenomenon known as time decay. Options lose value as they approach expiration, particularly accelerating in the final 30 to 60 days. This decline, often referred to as theta, means that an option’s extrinsic value diminishes with each passing day, even if the underlying asset’s price remains stable.

This effect is relevant for out-of-the-money options, which rely solely on extrinsic value. Closing these positions sooner can prevent further value erosion. For in-the-money options, time decay still reduces the overall premium, even with intrinsic value. Monitoring time left until expiration is important to determine the optimal moment to close and maximize gains or minimize losses.

Brokerage Fees and Commissions

Brokerage fees and commissions are an important financial consideration. Fees vary by firm and closing method. While many brokers offer commission-free options trading, specific fees may apply. Selling to close an option typically incurs a per-contract commission, and exercising an option often involves a separate exercise or assignment fee, ranging from approximately $0 to $45 per contract. These fees can impact net profit or loss, especially on smaller trades, so review your brokerage’s fee schedule.