it can be as described but much less so than in the past. the more typical purpose in buying a put is to create the equivalent of a short position with loss limited to the price paid for the put.
I'm not sure if someone mentioned this above, but I can't think of any good reason to exercise a put option. Sometimes people exercise a call option in order to capture a dividend, but when you exercise a put option, you're throwing away all time premium (extrinsic value) left in the put option. Since american options can be exercised at any time, the premium of the put option will contain both intrinsic (if the option is ITM) and extrinsic (time premium). The intrinsic value will always be equal to the amount that the option is ITM because someone holding the option can exercise it at any time and always get that amount. Only case that I can think of to exercise is if the option is way deep in the money or not liquid so that the bid / ask spread is wide, but even then if the option is priced just one cent or two less than the intrinsic value, someone will buy as they could use it as part of a risk free trade. Also, most brokers aside from IB charge an extra fee for exercise / assignment.
"the insurance policy metaphor is how I explained it to my wife . that is the humorous and realistic part of your post.
Thats what I was trying to say. You'll always get intrinsic plus the bid time value. I don't understand how he thinks he can get more.(?) The other thing, you might want to consider is... depending on the underlying stock price and the amount of funds you have, they won't let you exercise it unless you have that much margin buying power in your account. So say he has 1 contract on CMG... he needs $40,000 margin buying power to exercise. I suspect if he's asking this basic of a question here (no offense meant), that is not the case.
Yes, selling the option is the easiest way out. But ITM markets may not be very liquid. Deep ITM may have no quotes at all. It's easy to see this with volume and pricing. If you have to sell ITM, you may have to settle for less than intrinsic. The quick and easy way out is to exercise and cover with the UL. There are, of course, many ways to hedge a profit, as well - depending on the situation and the risks one is willing to take.
Hmmm. Not saying that'll never happen...but I have never seen it, even on illiquid options. I have had to sell before at intrinsic and zero time value...with calendar days left.... and those only went through on a downtick so maybe intrinsic minus a cent or two...but never really taken a bath on one. Albeit I paid up time- valuewise when I bought it. But never stuck.
And you should always be getting intrinsic value on an exercised put. Reason why is because there are lots of large banks out there with practically zero execution cost and automated algorithms looking for arbitrage opportunities. If one could buy a put option for less than the intrinsic value, then they can construct a trade such that they can lock in a profit with zero risk. Actually, if I was a broker and one of my clients tried to sell a put for less than the intrinsic value, the order would never even reach the market. I'd buy it for less than intrinsic value and exercise it while simultaneously shorting the underlying...although that might be illegal...depending on broker agreement / SEC rules.
No Put options is for selling your shares. If you want to exercise your puts that you bought, you would've already bought the underlying stock BEFORE you have bought the puts and still have them in your portfolio. Using your example, assuming you still have the underlyings in your portfolio, you would sell your shares at $30 strike price so if the underlying is currently at $20, you would've made a profit of $10 (30 - 20) per share minus all the exercise fees and commissions and etc. But if you have bought the underlying shares at $30, then you wouldn't have made any profit because the strike price is also at $30. $30 - $30 = 0. So as you can see, put options are like insurance on the shares that you bought in that it allows you to sell your existing shares at the strike price when the market price of the underlying shares is lower so that way you are protected from any losses that you may incur on your stock. Now just like any insurance, if everything is going well, then the policy is worthless. Same thing with the put option. Let's say the current market price of the stock is now $40, higher than the put option then the put option is worthless because you wouldn't want to exercise it. WHY would you want to exercise the put option to be able to sell your stocks at $30 when you can sell them for $40, $10 higher in the market? Hope this helps.