Strategies and Risks of Selling Put Options

The stock market is one of America’s most popular investment platforms. The market gives investors an opportunity to own a piece of corporate America in exchange for an equal opportunity to make a solid return on their investment dollars.

Most stock investors under the basic concept behind buying/selling stocks. For astute investors who are willing to dig a little deeper, there’s other strategies they could use to create other profits. The options market offers a lot of alternative investment strategies.

Stock Options Background Information

According to the website, a stock option is an investment instrument “that gives its holder the right to buy or sell a firm’s common stock (ordinary shares) at a specified price and by a specified date. Stock options are customarily a part of executive compensation package.” To clarify a couple of things, stock options represent the opportunity to buy or sell 100 shares of the underlying stock. Also, specified date refers to the expiration date of the options, which fall on the 3rd Friday of the applicable month.

There are in fact two types of stock options: a “call” gives the holder the right to buy 100 shares at a specific price (strike price) while a “put” option gives them the right to sell 100 shares at a specific price. As an alternative strategy to buying a call or put option, investors can choose to sell a call or put option.

Selling an option is often referred to as writing an option. If the investors actually owns 100 shares of the underlying stock, they would be writing a “covered” option. If they don’t own any of the stock, they would be writing an uncovered or naked option. Within any of these scenarios, there’s several interesting investment strategies an investor could employ.

In the following sections, the focus is going to move towards strategies that involve writing or selling puts. Hopefully, this information will serve as an education that will give novice investors another way to invest their money and create investment income.

How to Sell a Put

The process for selling a put is pretty straight forward. Through your online account or via a direct interaction with your broker, you will place an order to sell a put. You can put the order in at market or at a stated price. Once you have the sold the put, you have given the buyer the right to make you buy the underlying stock at the strike price of the put.

Applicable Example: You make a decision to sell or write a put option on IBM with a current valuation of $135.50 a share. You are going to write a October 135 put (it’s currently August 13). You write the put option and offer it for sale at $3 a share for which you will collect $300.

Put Option Selling Strategies

When you write or sell a put option, you should be doing so with one of two strategies in mind.

1. Selling Puts to Facilitate Buying Stock – You are selling the put in anticipation of the stock closing at a price higher than the put’s strike price. In this above example, the stock is sitting right on the strike price. You are effectively wagering that IBM’s stock price will be above $135 when the put expires. If IBM is at $140 on expiration date, the buyer would not exercise the option, allowing you to pocket a profit of $300 for writing the put. Should the stock sit below $135 upon the option’s expiration date, the buyer of the option would require you to buy the stock at the strike price of $135 a share. If you consider that to be a fair price, you should be satisfied with the transaction.

2. Selling the Put for Income – If you sell puts and collect premiums on a regular basis, you have effectively created an income stream. If you use this strategy on high priced stocks, the amount of income you can collect could be substantial. However, there are risks. In the above example, your income stream would be the $300 you collect for the put you wrote.

Risks of Selling Put Options

The risk that comes with this strategy is there will be times you are required to actually buy the underlying stock while the actual stock price sits well below the strike price. You would be in a loss position if the amount you collected when you sold the put is lower than the difference between the strike price and the actual stock price at expiration. If you don’t have the cash available to absorb the purchase of the stock, you would have to simultaneously sell it at the market price, leaving you with an immediate loss.

Can You Make a Living Selling Puts?

The short answer to the title question is yes. If you were able to generate enough net income from transactions on a regular basis, it’s quite possible you could support yourself and your family with said income. It would require you to maintain enough working capital to adsorb a few loss positions along the way.

The Best Put Options to Buy

As a rule of thumb, you would want to sell puts that can create a lot of premiums. This would require you to focus on high valued stocks that have very active trading patterns. You don’t want to get caught in a put selling strategy that takes away your decision-making flexibility.

Selling a Covered Put

This strategy would require you to short 100 shares of the underlying stock for every put option you decide to write. In doing so, you would have a limited profit potential with an unlimited loss potential. This option is not for conservative investors. It requires the investor to aggressively assume the underlying stock is going down by the time the sold put expires.

Other Tips

Selling put options would be considered a bullish strategy because you are wagering on stock prices going up, allowing you to pocket the premiums. For the most part, selling puts is safe unless you choose to do so under highly volatile market conditions where losses can mount in a hurry. Investors are warned to never play options with monies that are needed to sustain life.