Selling Puts - The other side of Stock Option Contracts
Derivatives are financial contracts, and options are a type of derivative. Options agree to exchange funds between two parties under specific circumstances. You may be aware of the buyer side of the option contract.
Stock options are common bought by investors. However since the option is a two sided contract, you can explore the sell side of it to make money. Learn how you can generate cash selling puts.
A put option is the right to sell a stock at the strike price on or before the expiration. It is the opposite of a call option. Buying a call is bullish view of a stock, where buying a put is a bearish view.
Assume stock ABC trades for $50 a share. An investor expecting a drop in the strike price may purchase a put at a strike of $45. The writer of the put collects the premium but is now obligated to buy shares under the conditions of the option. The stock experiences some selling and drops to a price of $40. The put buyer may now buy at the market price and the writer must buy them at the strike price. The buyer will profit the difference between the market price and strike multiplied by the number of shares, minus the premium paid.
One way to profit from selling puts is from the option premium. The put buyer pays the premium to the writer. When the option matures without reaching the strike, the writer profits the premium. In this case you want to choose a strike and a maturity so that the put will expire worthless.
Investors with long positions often buy puts as hedge. The long investor is holding the stock hoping for a continued increase. Since the put option provided leverage, the long investor can invest a small amount of capital to hedge against a drop in the price. By selling puts to these investors neither of you wants to exercise the option.
You can accumulate shares of a stock by selling puts. You would choose a price that you would buy shares at. Then you sell puts at that strike. You will buy shares at your price when the stock drops below the strike. Conversely if the stock never reaches your strike, then you have gained the premium. This is similar to a limit order. You will either buy shares at your selected price, or the limit order expires. The difference is that you gain the option premium in either case.
Another way to make money selling puts is with a vertical spread. With a spread, you both buy and put and sell a put. A bull put spread is where you buy a put at one strike and sell a put at a higher strike, both with the same expiration. If both options end in the money, you buy at the low strike and sell at the higher strike. Your profit is the difference in strikes multiplied by the number of shares.
Buying one strike and selling a lower strike is a bear put spread. Again, subtract the low price from high price times the number of shares to determine the profit. In either the bear or bull put spread, the end result is similar.
With a spread the premium paid is reduced by the premium gained, making it cheap to establish the spread. Plus any time decay lost in the put you bought is gained in the put you sold. In other words the time decay is hedged.
Unfortunately the potential gain from a spread is fixed. You can never make more that the shares times the change in strike prices. With a spread that is exercised you have agreed to both buy and sell shares of stock at prearranged prices. That difference is the amount you will profit.
Stock options are common bought by investors. However since the option is a two sided contract, you can explore the sell side of it to make money. Learn how you can generate cash selling puts.
A put option is the right to sell a stock at the strike price on or before the expiration. It is the opposite of a call option. Buying a call is bullish view of a stock, where buying a put is a bearish view.
Assume stock ABC trades for $50 a share. An investor expecting a drop in the strike price may purchase a put at a strike of $45. The writer of the put collects the premium but is now obligated to buy shares under the conditions of the option. The stock experiences some selling and drops to a price of $40. The put buyer may now buy at the market price and the writer must buy them at the strike price. The buyer will profit the difference between the market price and strike multiplied by the number of shares, minus the premium paid.
One way to profit from selling puts is from the option premium. The put buyer pays the premium to the writer. When the option matures without reaching the strike, the writer profits the premium. In this case you want to choose a strike and a maturity so that the put will expire worthless.
Investors with long positions often buy puts as hedge. The long investor is holding the stock hoping for a continued increase. Since the put option provided leverage, the long investor can invest a small amount of capital to hedge against a drop in the price. By selling puts to these investors neither of you wants to exercise the option.
You can accumulate shares of a stock by selling puts. You would choose a price that you would buy shares at. Then you sell puts at that strike. You will buy shares at your price when the stock drops below the strike. Conversely if the stock never reaches your strike, then you have gained the premium. This is similar to a limit order. You will either buy shares at your selected price, or the limit order expires. The difference is that you gain the option premium in either case.
Another way to make money selling puts is with a vertical spread. With a spread, you both buy and put and sell a put. A bull put spread is where you buy a put at one strike and sell a put at a higher strike, both with the same expiration. If both options end in the money, you buy at the low strike and sell at the higher strike. Your profit is the difference in strikes multiplied by the number of shares.
Buying one strike and selling a lower strike is a bear put spread. Again, subtract the low price from high price times the number of shares to determine the profit. In either the bear or bull put spread, the end result is similar.
With a spread the premium paid is reduced by the premium gained, making it cheap to establish the spread. Plus any time decay lost in the put you bought is gained in the put you sold. In other words the time decay is hedged.
Unfortunately the potential gain from a spread is fixed. You can never make more that the shares times the change in strike prices. With a spread that is exercised you have agreed to both buy and sell shares of stock at prearranged prices. That difference is the amount you will profit.
About the Author:
Max pain teaches us that the stock price will likely close on option expiration between the maximum put open interest and highest call open interest. Visit weekly-max-pain.blogspot.com for aapl max pain and open interest graphs that will assist you selecting strike prices.
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