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Option Strategy Put Option

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A put option is a contract has three participants; the clearinghouse (institution that enables to offset transactions with one another in order to limit payment settlements to net balances) and the two sides of the transaction one side is the seller of the contract and the other side is the buyer.

A buyer of a put option contract has the right but not the obligation to sell the underlying security at the strike price, no matter what the underlying security’s price on the market.

The put options seller (writer) contract has the obligation to buy the underlying security from the contract holder. The seller has to have enough capital to back the contract.

The role of the clearinghouse is to check if initiation of the trade is possible, and to maintain (mark to market; an act of assigning a value to a based on the current market price) the position on daily and intraday basis. From inception to expiration, the clearinghouse acts upon the options buyer’s request to exercise the contract (if it is an American style). A transaction leads to a one open position in the market (see note, below).

Note:
The most popular and widely used put option is by insurance companies.

For example, in car insurance, the buyer of put option contract is the car owner and a reasonable premium will pay for car insurance is 10% of car value. On the other side the writer of the put option is the insurance company. The insurance is activated when one of the contract agreements occurs, for instance, if a car accident makes the car partially or totally demolished, the insurance company will pay the reparation.

The clearinghouse is the insurance authority and its role is to regulate and overseer the insurance companies and their ability to compensate in extreme cases.

The insurance companies are supposed to cover their own capital or use a big underwriter like Lloyd’s (London insurance underwriting corporation of many separate syndicates).

The gray line shows the actual P&L at the position inception time (or buying an existing put option contract on the exchange).
No other variable changed, except underling security price, P&L = zero at the price of $50.00, P&L = $1.68 at the price of $47.00, P&L = -$1.42 at the price of $54.00, notice that the P&L is not linear to the underlying security's values.

The black line shows the P&L at the expiration, if the underlying security price stays $50.00, the option buyer loses the premium paid $2.58.

The breakeven point at expiration is $47.42, below this price the options buyer starts to profit.