Selling put options is one of the more useful options strategies to have in your proverbial trading tool belt.
Many new option investors might just buy a put option to bet on a stock going down but selling puts can be one of the more consistent income generating strategies for a portfolio.
In this article we are going to discuss various strategies and examples of selling put options. Let's get started.
Selling Puts vs Buying Calls
Selling puts and buying calls are both bullish strategies because they both profit when a stock goes up.
The main reason for selling puts vs buying calls is because you don’t know when a stock will move so being long calls can erode with time value. Whereas, you can profit from selling puts if the stock either doesn’t move or goes up.
When selling puts you don’t have to predict when the stock will move up because you profit as long as the stock price stays above the put option’s strike price.
Image Source : Selling Put Options Profit Loss Graph
Selling Puts For Income
If you have read our overview article about options then you understand that options are priced based on statistical probabilities.
The reason that put selling can be very profitable over time is because statistically the general bias for stocks is up and the pricing bias for option pricing is higher for puts than calls because stocks can fall faster than it takes to rise. This means that option sellers will price in higher extrinsic value into put premium vs. call premium.
Both of these factors can allow an option seller to sell far out of the money options that statistically will expire out of the money more times than in the money.
Selling puts for income is a very, very popular strategy that can be combined with multiple options at once to control risk.
Let's get into some of these put selling strategies.
Selling Puts Strategy
Selling Covered Puts
Selling covered puts is a bearish strategy that isn’t used very much because you have limited profit potential while assuming lots of risk. The risk occurs if the stock goes up in price since you would be short the stock. This strategy involves shorting the stock betting that the stock will drop and then sell puts at the same time.
Selling Puts to Buy Stock
Selling puts to buy stock is also call naked put selling and can be a great strategy for stocks that you want to buy at a certain price that is lower than current prices.
You can sell put options at the strike price that you want to own the stock and collect the put premium as income. You keep selling the put option every expiration period until the stock is put to you. The stock would be "put" to you if it drops below your put's strike price.
The only negative part of this strategy is if you are bullish on a stock then it might continue to go up and you would miss out on buying the stock because you were waiting for it drop below your put strike price.
Put Credit Spreads
Another selling put options strategy is called selling put spread for a credit and is probably the most popular put selling strategy there is. It is popular because it has a very controlled risk/reward and can generate a very good return on investment.
This is a bullish strategy where you simultaneously sell a put option that is closer to the current stock price and buy a put option with a farther away strike price than the put option that you sold.
This creates a “credit” or deposit into your account because the put option you sold is worth more than the put option you bought. The goal is to have the stock stay above the strike price of the put option you sold and have both put options expire worthless allowing you to keep the entire premium sold.
In this article, we have discussed just a few of the strategies that involve selling a put for income.
There are many variations of these that combine different expiration periods and strike prices which provides for lots of flexibility in your investments.
Hopefully this article gave you some insight into the many opportunities that put selling can offer and is one of the common option strategies used by professional investors to control risk and generate income.