The easiest way to thing of options is that they give you a right. A call option is a right to buy at a certain price, before a certain date. A put option is a right to sell at a certain price at a certain date. These rights are independent of the stock, but the price of the stock has a big impact on the value of the options.
I purchased seven May 8th $83 put contracts for 88 cents each for a cost of $616. The current market value is $88.
You now have the right to sell 700 shares of the security at $83, any day prior to and including the expiration date.
From what I understand, that is out-of-the-money and I would not want to sell because I would be losing money, correct?
Really what matters is the market price of the option. Options are generally cheaper:
- The more out-of-the-money they are;
- The closer they are to expiration; or
- The less volatile the stock is, or the less volatile the market thinks the stock will be.
Another way to think of it is that the likelihood that you could make a profit from the option is decreasing if any of the above things happen.
However, it is possible that the stock could move either making the stock more in-the-money or become more volatile (causing option prices to increase).
Do I just let them expire? Is my premium the $616 that I will be out at expiration? Should I sell it before it expires?
If you don't want your option position, you would be better to sell it sooner than later, but you need not place a market order or sell them at the market price. You can place a limit order at a price closer to what you paid, and steadily decrease it. If you let it expire, and it expires out-of-the-money then it will be worth zero. You are already out the premium, but you might be able to get some of it back.
Can I be forced to pay the full price of $58k for all 700 shares? If not, what is the worst case scenario?
If the option expires in-the-money you can choose to exercise the option. This will happen automatically unless you instruct your broker not to. This is usually profitable, because you would be selling the stock for more than the market price on expiration day. But if you don't have the stock, you might be better off trying to sell the option in the market prior to expiration.
At what point would you sell if it starts to drop and you are in the money?
It is the same as if you held a stock and the stock price went up - when do you sell? If you want to just get out of the position, sell at break-even (your original cost + transaction fees), or if you want to make a small profit, sell it a little higher, but less likely to do the trade. You could sell some at a lower price and some at a higher price.
I did not understand what I was getting into when I bought this so lesson learned the hard way.
In that case, try to sell it at break-even, and if you are not filled decrease your price slowly until the position is closed. Each day that goes by the option will be worth less and less. You can sometimes "roll-over" your position, which means you are exchanging a short term option for a longer one, but I would suggest getting to understand options more before doing another trade (which this would be).