If I own a put option on XYZ, and XYZ becomes worthless, is my option also worthless?

Question

This is a hypothetical question. Let's say I believe XYZ is in real financial trouble, so I purchase some seriously OTM put options on the cheap. Before the expiration, XYZ goes bankrupt and their stock becomes worthless. Are my put options also now worthless?

If they were call options I can see that yes, they would be worthless because I own a right to overpay for someone else's garbage shares and I just wouldn't. But if I owned a put, someone else has an obligation to overpay for my garbage shares, and I'd certainly want to collect on that obligation.

On one hand, I'd think the options would be worthless because if XYZ is bankrupt, I couldn't physically buy the 100 shares I'd need to pawn off on the loser that promised to pay me for them. But on the other hand, I couldn't buy an option so far out of the money because no one would sell it to me, making me think they wouldn't be so worthless after all.

So what would happen in this scenario?

Answer 1

If an investor owns put options on the XYZ stock with a strike price of 40 and the XYZ is declared completely worthless then when the investor exercises his/her options he/she will get $4000 per contract. However, it will take a long time for the stock to be declared worthless. Therefore, it is often better to sell the option.

Answer 2

A put option can be settled by delivering the stock and receiving the agreed payment. Even if the stock is worthless, the stock certificates can still be delivered and the agreed payment received. So the put option holder should be fine if the stock becomes worthless.

Bankrupt shares often still trade, so you can buy them. Even if they do not trade, they can be found by institutional traders. Therefore your put option should retain its value: Even if you can't find the shares you need to deliver, you can sell the put option at a high price to someone who can find them.