How to sells calls and puts
Traders sell calls and puts depending of their assumption. They will receive option premium upfront by selling options.
In this yield-seeking environment, selling options is a strategy designed to generate current income.
We sell options with high implied volatility. We want the option to expire worthless or we buy them back when they are much cheaper. If you the options expire worthless you may keep the entire premium.
However, selling options is little bit more complex than buying options. It also involves additional risk, but your probability of profit is much better. In this article you will learn how to sell options as well as several strategies that involves selling calls and puts.
The ins and outs of selling options
Traders do sell calls and puts. Let us start with people that buy an option. Someone who buys an option get the right to buy or sell an underlying security at a specified strike price. The buyer has no obligation.
Traders that sells an option is obligated to buy or sell an underlying security at a specified strike price if the option is excised. For every option that is sold there is also a buyer.
A trader that sells options need to make the following decisions:
- Choose options out of your watch list
- Look for options that has high Implied Volatility
- Is the selected option liquid
- What type should I sell Calls or puts
- Which strategy will I use
- How much capital to use per trade
- How many contract to sell
- The expiration month
With this information, goes to their brokerage account and select a security. Once an option has been selected, the chooses a sell to open order to sell options.
A trader has to decide when to sell calls and puts. What type of option you are using is depending on your assumption. Do you think the underlying will go down sell calls and when you think the underlying will go up you choose to sell a put. Of course you choose option
Uncovered strategies involve selling options on a security that is not owned. An uncovered position would involve selling April call options on a stock the investor does not own. It is also called selling a naked call.
Selling naked calls involves unlimited risk because the underlying asset could theoretically increase indefinitely. You can sell an one strike out of the money call though, this option has in general a 60% probability of profit.
When the option moves in the money a trader might use his right and exercise the option. You got assigned. If assigned, the seller would be short stock. You have to buy the security on the open market at rising prices to deliver it to the buyer exercising the call at the strike price.
The same idea of selling put is similar as that of selling calls. The goal is to sell options with a lot of premium that they expire worthless or to buy them back for a lower price.
The strategy is called naked puts when selling puts on a security that is not being shorted at the same time. The seller of a naked put hopes that the underlying asset will increase in price. The trader can take risk of the table by buying the option back or waits for the option to expire worthless.
Selling naked puts involves significant risk as well. Maximum potential loss is limited because an asset cannot decline below zero.
There is second reason someone a trader is selling puts. An investor might be interested in buying stock of a company. The investor can buy the stock outright but he/she can also sell a put option with a lower strike price. By doing this an investor can accomplish several goals.
First, he or she can keep the option premium if the stock closes above the strike price and the option expires worthless. However, if the underlying price declines in value, and the owner of the option exercises the put, the seller will have purchased the stock at a lower price then if the investor had bought it at the time he or she sold the option. If the stock falls below the break-even price of the assigned shares, losses may occur.