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executives who became fabulously wealthy when they exercised warrants paid to them as part of their
employment compensation.
Put Options
The second type of option is a put. A put option is a contract that gives the owner the right but not the
obligation to sell some underlying asset for a prespecified price, on or up to a given date. Consider a
put option on Exxon stock. Suppose the strike price is $100 and the expiration date is December 15.
The put option owner has the right, but not the obligation, to sell a share of Exxon stock for $100, on
or up to December 15. If the market price of Exxon is above $100, for example $120, the put option
owner would not exercise. Why should he force someone to pay $100 for the stock? He can make
more money by selling the stock in the open market. Thus, a put option is out of the money if the
stock price is above the strike price. If the stock price is below the strike price, however, then the put
option is in the money. If the market price of Exxon is $80 on December 15, the owner of the put can
reap a $20 payoff. To realize this payoff, he would buy the Exxon stock in the marketplace for $80,
and then turn around and sell it for $100 by exercising the put option. Thus, a put option is in the
money when the stock price is below the strike price. A put option‟s payoff at expiration, and its
intrinsic value prior to expiration, is the strike price minus the stock price, or zero, whichever is
greater.
Exhibit 15.3 presents the payoff diagram for a put option. Should the stock price fall to zero, the put
option‟s payoff would be equal to the strike price. At that point the put option owner would have the
right to sell a worthless stock for $100. From that point, the put option payoff falls one dollar for each
dollar that the stock price rises. The payoff reaches zero when the stock price equals the strike price,
and then remains at zero no matter how much higher the stock price goes. As is the case with call
options, the put option cannot fall in value below zero. Once the put option premium is paid, the
owner is never called upon to make another payment. Any subsequent cash flow is positive. It is
altogether possible, however, for the buyer of the put option to lose the entire premium, so one should
not think that buying a put option is a safe investment.
Exhibit 15.3 Put option payoff diagram.