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Selling Put Options: How It’s Done & How Easy It Can Be
Martin Denholm, Contributing Editor
Tuesday, July 14, 2009: Issue #1040
Editor’s Note: There has been an incredible amount of interest from Lee Lowell’s put option strategy article from the last two weeks – and his unbroken winning streak in his Instant Money Trader premium service. But we’ve also seen a few questions pop up as well. So today we turn to Contributing Editor, Martin Denholm, to break down Lee’s strategy on selling put options a little more.
The “buy-and-holders” just got killed again…
With the market’s plunge last week, many regular shareholders have seen their portfolios awash with more red numbers.
Tough break for them. But savvy investors know that this offers a great chance to value shop and buy back in. And one of the most effective and profitable investment strategies that you can use in a market like this is one that generates income… no matter what happens.
This can be done by selling put options.
So let me show you a little more about this options trading strategy – how it’s done and how easy it can be for the average investor.
Busting The Myths of Selling Put Options
If you’ve gotten this far, you’re on the right track. Many investors hear the words “put options” and “selling” in the same sentence and head for the exit. Too complex. Too confusing. And downright scary. Or so the myth goes.
Let’s bust that myth right away: Selling put options isn’t difficult to execute. In fact, it’s actually easier than most investment methods.
When you place a put-sell trade:
- You don’t have to buy a stock.
- You don’t have to sell a stock.
- It’s got nothing to do with bonds or currencies.
- And there are no complex parameters to the trade.
Here’s the deal: You’re either going to make money, or you’ll end up investing in a company at a ridiculously low, discounted price.
What you try to do is buy stocks for the price you want. And just for trying, you get paid. Think of it like Priceline.com – where customers name the price they want to pay for airfare and hotel rooms – except with stocks. The biggest difference is that you’re getting paid for your time.
It works in rising markets… falling markets… flat markets… any market. It’s a regular stock-buying strategy with a profitable twist upfront. Here’s how you can use it…
Selling Put Options In Four Easy Steps
Have you ever wanted to buy a stock but passed because the price is too high for your liking?
Most ordinary investors would simply sit on the sidelines and wait for the price to fall to a better level. But smart investors know they can still get in the game by selling a put option on it instead.
Here are the four steps you need to take when selling put options:
- Pick your chosen stock.
- Decide on a lower price, where you’d feel comfortable buying the shares.
- Check the put option prices for that level. For example, if the stock is trading at $20 and you want to buy it for $15, you’d select the $15 strike price and an expiration month.
- You then sell those put options. Since each stock option contract is equivalent to 100 shares, you’d sell five put option contracts if you want to buy 500 shares.
When you enter a trade like this, you’re obligated to buy those shares at your stated strike price by expiration. Keep that in mind when selling the contracts, so you don’t overextend yourself. For example, if you sell one $15 put option contract, you’ll need to have $1,500 on hand by expiration day to cover the cost of the shares ($15 x 100 = $1,500).
Note: You don’t need to have all that money on hand while the trade is open. Your broker will only ask you to keep a fraction of that amount available – known as a “margin requirement.” Consider the trade as a “buy now, pay later” type of deal. You’re putting off paying for the stock until a certain scenario occurs (see below).
In exchange, the option buyer will pay you for each contract you sell while you wait. This is known as a “premium” and is deposited into your trading account. (The farther out the expiration date, the more money you’ll receive when selling the option.) Meanwhile, ordinary investors are waiting for the price to drop without collecting any money.
Okay, then what happens?
On options expiration day, you’ll have two scenarios when selling put options:
- If Your Stock Trades Below $15: For every put option contract you sold, you’ll be obligated to buy 100 shares at $15 each. This is what you wanted – a 25% discount from its $20 price when you executed the trade. Plus, you get to keep the money that the option buyer paid you. The shares will appear in your account on the Monday after option expiration. It will now be a regular long position and you must manage it as you would any other stock. That’s why it’s important you pick a price at which you’re comfortable holding the shares.
- If Your Stock Trades Above $15: The put options will expire worthless. You won’t get to buy the shares at your chosen price, but you will get to keep the money for selling the contracts, just for trying.
So regardless of what happens, you keep the money from selling the put options upfront. Now let’s bust another myth…
But Isn’t Selling Put Options Riskier Than Buying Shares?
Selling put options is no riskier than buying shares outright.
- When you buy shares, the risk is that you lose your entire investment.
- When you sell a put option, you’re obligating yourself to buy shares, too… but at a much lower level than the current share price.
- And if you do end up buying the shares, your risk will be the same as a regular shareholder.
The difference is that nobody pays you cash to buy stocks outright – but they do when you sell put options. Selling puts is just another way to invest in the options market.
While some brokers see selling put options as riskier than stocks (and require that you keep more capital reserves on hand), your risk only kicks in if you’re obligated to buy the shares. And even then, you’d simply be long on the stock, with the same risks as with any stock holding.
Perhaps the biggest obstacle for most investors is that you need to be “approved” to sell puts. This means that you must apply through your brokerage. It’s a simple process , similar to filling out forms when you opened the account.
If you have questions, contact their customer service department and they can help.
An Important Note on Selling Put Options
Many folks don’t know about option trading strategies like put-selling, and Investment U will be working hard to bring you more like this in the coming weeks and months. But we wanted to give you an example of what’s working in the market right now.
It’s certainly not as risky or complicated as some people would have you believe.
And for those of you who know Lee Lowell, you’ll know he’s not a gambler. In fact, he’s one of the most conservative, risk-averse investors I know.
That said, selling puts isn’t necessarily for everyone. You’ll need to check with your broker to make sure you’re approved to trade options – and specifically, selling put options.
Good investing,
Martin Denholm
P.S. If you want to take advantage of today’s financial mess by buying stocks at a big discount and putting “bonus checks” in your pocket just for trying – then check out Lee’s Instant Money Trader, which is dedicated exclusively to selling put options. It’s perfect for a market like this.
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6 Responses to “Selling Put Options: How It’s Done & How Easy It Can Be”
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July 14th, 2009 at 12:43 pm
Good Article! The only risk with this in a market like today is you could end up at expiration paying $15 for a stock that has gapped down to $8. Talk about a huge loss. I can see this working great in a flat or slightly bullish market where there is a natural pullback of the stock, but we are in a bear market rally that looks like it’s about to turn over again. I personally don’t want to own anything long in this environment. That said… maybe you could write a follow up article on buying back the put at a bit of a loss in case there is a large gap down in the stock before expiry, and how that works!
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July 14th, 2009 at 1:08 pm
In this article below it seems to indicate that you only have to buy the shares at expiration date. But with most calls the buy of the option can request assignment at any time. Isn’t that true with puts? Can’t the buyer of the option force the seller to buy the shares at the strike price at any to upto the experation date?
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July 14th, 2009 at 7:40 pm
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The risk is a downturn that drags all boats lower, making you honor the contract as the stock drops lower than the strike price……think October, 2008, or November 2008, or March 6th, 2009.
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That is 1500 shares of some stock ($30/share put value=$45,000) versus a gain of
$825 or 1500x$.55, that you are wagering will expire before the strike price (say $30) occurs. You now have to buy 1500 shares to cover the contract and tie up $45,000, that may be in a stock trying to set new yearly lows.
In this example you risk $45,000 (all or part) to make $825.
Those odds don’t look very good to me since a $.02 positive move in the share price is higher than the $825 “put” risk.
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July 15th, 2009 at 11:31 am
Re: Lee Lowell’s “Put Options Strategy.”
I agree writing put options can be a good strategy. Many years ago I experimented and learned quickly that most options expire worthless. At that time I was approved by a broker to write them which showed some profit.
However, I believe with today’s rules and regulations it makes it very difficult for a person to get approved higher than writing covered call options.
When banks started to get in to investments, I opened an investment account for fifty thousand with a bank that I have been a customer for many years. I also had about fifty thousand in savings in one form or another with them. I could not get approved any higher than writing covered calls with them.
I have not pursued to find out what dollar amount would be needed in an account to qualify to write options but it must be more than the average small investor. Your program must be for millionaires.
Frank
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July 15th, 2009 at 2:26 pm
I have subscribed just for enjoying it but when i went through your article it influenced me . Previously i have confusion about options but really your article cleared my doubts.Thanks a lot.I will definitely wait for such articles.
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July 19th, 2009 at 1:58 pm
If the stock goes lower than the price you sold it at you can always roll it over. I just did that with a put I had. I still am making money on the put.
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