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Roman Baker
Roman Baker

Selling Puts To Buy Stock

Since volatility is one of the main determinants of option price, in volatile markets, write puts with caution. You might receive higher premiums because of greater volatility, but if volatility continues to trend higher, then your put may increase in price, meaning that you will incur a loss if you want to close out the position. If you perceive the volatility increase to be temporary and expect it to trend lower, then writing puts in such a market environment may still be a viable strategy.

selling puts to buy stock


By selling a cash-covered put, you can collect money (the premium) from the option buyer. The buyer pays this premium for the right to sell you shares of stock, any time before expiration, at the strike price. The premium you receive allows you to lower your overall purchase price if you get assigned the shares.

But what happens if you are not assigned the shares on or before expiration? You keep the premium. While your intention may have been to own the stock, at least you received some incentive for waiting around for the stock to drop in price.

With cash-covered puts, the profit potential has 2 components: the option trade, and if the stock gets assigned. The most you can make from the option trade is the premium. If the stock is assigned and you are given ownership, your upside is potentially unlimited if the stock moves higher.

Cash-covered puts also have substantial risk because, if shares of the underlying stock fall below the strike price or even go all the way down to $0, you will still be obligated to buy shares at the original strike price. You can see how the risk involved with a cash-covered put differs from using a limit order to buy a stock.

in other words, you're selling 1 contract representing 100 shares of stock XYZ, and will be obligated to buy that stock if the party who purchased this contract decides to exercise their option. With contracts on individual stocks, this could happen at any time, and it normally occurs when XYZ is at or below $50 per share. By entering into this contract, the buyer will pay you a premium of $2.30/share ($230 total for the contract).

If, at expiration, the stock is worth more than $50 per share, the put option more than likely expires worthless, and you get to keep your premium. You are not required to buy 100 shares of XYZ, so you do not participate in any additional profits if the stock continues to rise above $50.

If the stock is less than $50 at expiration, then the contract will more than likely be assigned and you will buy 100 shares of XYZ. Shares will be automatically purchased for you at the strike price of $50, but since you received $2.30/share from selling the contract, your effective purchase price is $47.70/share. As the option portion of the trade is now completed, your gain and loss now will be based on the movement of XYZ shares above or below your purchase price.

Put options are a type of option that increases in value as a stock falls. A put allows the owner to lock in a predetermined price to sell a specific stock, while put sellers agree to buy the stock at that price. The appeal of puts is that they can appreciate quickly on a small move in the stock price, and that feature makes them a favorite for traders who are looking to make big gains quickly.

One option is called a contract, and each contract represents 100 shares of the underlying stock. Contracts are priced in terms of the value per share, rather than the total value of the contract. For instance, if the exchange prices an option at $1.50, then the cost to buy the contract is $150, or (100 shares * 1 contract * $1.50).

Put options are in the money when the stock price is below the strike price at expiration. The put owner may exercise the option, selling the stock at the strike price. Or the owner can sell the put option to another buyer prior to expiration at fair market value.

A put owner profits when the premium paid is lower than the difference between the strike price and stock price at option expiration. Imagine a trader purchased a put option for a premium of $0.80 with a strike price of $30 and the stock is $25 at expiration. The option is worth $5 and the trader has made a profit of $4.20.

Imagine that a stock named WXY is trading at $40 per share. You can buy a put on the stock with a $40 strike price for $3 with an expiration in six months. One contract costs $300, or (100 shares * 1 contract * $3).

If the stock finishes between $37 and $40 per share at expiration, the put option will have some value left on it, but the trader will lose money overall. And above $40 per share, the put expires worthless and the buyer loses the entire investment.

Using the same example as before, imagine that stock WXY is trading at $40 per share. You can sell a put on the stock with a $40 strike price for $3 with an expiration in six months. One contract gives you $300, or (100 shares * 1 contract * $3).

In order to receive a desirable premium, a time frame to shoot for when selling the put is anywhere from 30-45 days from expiration. This will enable you to take advantage of accelerating time decay on the option's price as expiration approaches and hopefully provide enough premium to be worth your while. But what you consider a good return is up to you.

Imagine stock XYZ is trading at $52 per share, but you want to pay less than $50 per share for 100 shares. You sell one put contract with a strike price of $50, 45 days prior to expiration, and receive a premium of $1. Since one contract usually equals 100 shares, you receive $94.40 ($100 minus $5.60 commission).

What if the stock is at $48 as the options expire? The put will be assigned and you will pay $50 per share. Subtracting the $1 put premium received (less commissions), it is as if you paid about $49 per share. You may be tempted to curse and think you overpaid for the stock by $1 per share.

If you doubt the stock will make a recovery, your other choice is to close your position prior to expiration. That will remove any obligation you have to buy the stock. To close your position, simply buy back the 50-strike put. Keep in mind, the further the stock price goes down, the more expensive that will be.

Selling cash-secured puts is a substitute for placing a limit order on a stock you wish to own. You receive a premium for selling the puts, and if the options are assigned, the premium can be applied to the purchase of the stock.

The smart method here is to sell one or more cash-secured put options to take on the obligation to potentially buy the shares at a certain price before a certain date, and get paid money up front for taking on that obligation. You obligate yourself to do what you wanted to do anyway- buy the stock if it dips.

Selling put options at a strike price that is below the current market value of the shares is a moderately more conservative strategy than buying shares of stock normally. Your downside risk is moderately reduced for two reasons:

The horizontal axis gives a range of potential prices that the stock might be at during option expiration. The vertical axis indicates the rate of return over the lifetime of the option for each ending price, which was 3.5 months in this case. The pattern you see continues off the chart, from zero to infinity.

This company engages in oil refining and owns a stake in an MLP for oil transport, currently trades for $29.20 per share, and pays a 4.5% dividend yield. Shares took a big price hit when oil prices collapsed in 2015, as refining margins decreased, and the stock had been roughly flat ever since.

This tactic is excellent for overvalued markets, as well as flat/bearish markets, because you can generate high returns even as the stock price stays flat or falls a bit, and can build 5-10% or more downside protection into your portfolio.

It also includes a list of 50+ stocks and ETFs that I use as my baseline watchlist for selling options on. These are stocks and ETFs that meet all of the main criteria for being good securities for selling options on, and helps investors get started.

In general, you want to buy a put option when you have a bearish sentiment about a security. In other words, buy puts when you believe the stock's price will go down. Some traders use puts to hedge other positions they hold. For example, if someone owns a lot of Apple, they may want to buy an Apple put so they won't lose everything if Apple crashes.

Your next step to buying stocks at a discount is identifying which put option you are going to sell and then selling it. As an option seller, you have three choices when looking at which put option to sell. You can sell the at-the-money option, an out-of-the money option or an in-the-money option. When selling puts to buy stocks, you are typically going to use an at-the-money put option. At-the-money options offer a nice balance between paying a good premium and giving you a good chance of actually having the stock put to you.

Do you use good-til-canceled (GTC) limit orders to bid for stock below the current market? Many investors do. After deciding they are going to buy a stock, many investors will place a bid below the current market price, hoping for a dip in the stock price. This way, if they end up buying the stock, they feel as though they got the best deal possible.

Rather than waiting for a stock to hit your target purchase price, however, you might consider using options to collect money today for being willing to assume the obligation of buying stock if the stock moves to the lower price that you choose.

The risk when selling cash-secured puts is if the stock price falls significantly below the strike price. Since you are obligated to buy the stock at that strike price, you would be purchasing stock above then current market value. This is also true of placing a GTC order below the market; if the stock price drops significantly, you will buy the stock at or below the lower price if the stock continues to move lower.

The cash-secured put is a powerful options strategy that may help you generate income on your willingness to bid for stock below the current market. Open an account to start trading options or upgrade your account to take advantage of more advanced options trading strategies. 041b061a72


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