Selling puts for huge income
Selling puts is an essential part of options strategies. Selling a put is a strategy where an trader writes a put contract. By selling the contract the put buyer has the right to sell stocks for a certain price.
Selling options is advantageous to an trader, because she will receive the premium in exchange for committing to buy shares at the strike price if the contract is exercised. If the stock’s price falls below the strike price, the put seller will have to purchase shares from the put buyer when the option is exercised.
How does Selling Options work
One way to generate income is to sell option premium, You may sell puts At The Money or just one or two strikes Out of the Money. If the stock stays around the current price, or it rises a little, the investor keeps the premium when the option expires worthless. The strategy to sell a put is less risky then when you bought the stock outright and the break even is lower then the stock price!
The broker will block some money (margin) during the trade. So you need enough money in your account to cover the position in the event of exercise. What happens if the stock drops in price? In that case, the investor eventually gets assigned the shares. The Cost Basis for these shares is the strike price of the put minus the premium received.
Example of Selling a Put
A stock is currently trading at $ 22.50. You like selling options and decide to sell puts for extra income. An OTM put with a strike price of 20 can be sold for $2.50. You will receive $250 dollar in a your account for selling the put. Actually you sell option premium. The $250 is yours to keep. no matter what. If you get assigned you’ll end up paying $2,000 for 100 shares of stock. Subtract the $250, and your effective basis is $1,750, or $17.50 per share. That is a good deal! If you don’t want to keep the stock you can sell directly a $1.5 call against it. And you will receive directly another premium of $150 dollar. Create a Watch list with options you want to sell regularly.
When do you sell a Put?
You want to Sell a naked put when you expect the stock will rise. When you the put, you are anticipating that the stock price will go higher. Your are bullish and expect that the stock price will rice.
You have the same expectation when you buy a call option. The difference, however, is that people who are buying calls have to deal with time decay. The stock price needs to go up enough to cover the time value in order to make a profit.
Advantage of Selling Options
Put sellers have time decay on their side. The put decreases in value day by day. When the stock doesn’t move at all a short position can still be profitable. So a key distinction between long calls and short puts is that it is more difficult to profit from buying calls; it is relatively easy to profit consistently from selling puts. The reason: time value. The decline in time value works against the buyer, but it is a valuable benefit to the seller.
When you sell a put, you receive an option premium. This option premium is credited to your account. It is an income, but it also discounts the price of the stock in the event of exercise. So if the strike price is $20, and you get a premium of $2.50 when you sell the put, your cost basis would be $17.50 per share. So, you bring down your break even.
Selling puts is less risky
The risk of selling a put is almost similar as buying a 100 stocks. But you are much better of selling a put. You’ll get a much better break even and less much risk by selling a put versus buying that stock. If you buy the stock it is no less risky than selling the put. But you are putting yourself in a much better situation.
When you sell a put for premium you are taking in a credit. The credit is the most you can make. As long as the strike is above you put you can keep the credit at expiration. By selecting the strike price you can choose where you want to sell the stock for. Now the stock prices may drop all the way to $17.50 at expiration and you still have no loss. If it closes above $17.50 you still have a small profit. If it closes above $20. you may keep the whole credit. So, you can make money when the stock price rises, stays the same or drops a little bit.
Instead of waiting the options to expire you can close your position by taking profits early. As soon as it reaches 25% or more you may want to manage winners and close the position.
If you have sold a put you have always the risk that you get assigned. Then you have to buy 100 stocks for each put you sold. But since you have received a credit, you buy them with a discount. Directly after you got the stock delivered you can sell a call and receive a premium again.
Do you have a already a Trading Plan? Selling puts is an excellent way to receive option premium and create a steady income. Choose stocks you like to own because you have always the risk of assignment. If you want to trade expensive stocks sell options spreads in stead of naked options. You risk is limited to the width of the spread.