 Selling Puts Option Strategy
When you are bullish on the market and feel that it isn't
likely to go down in the short term, there is an option
strategy that is particularly attractive and is worth your
consideration. This strategy involves selling puts on a
quality asset that you would like to own at a discount.
With this strategy, you are selling someone the right to
sell you the underlying asset at a fixed price (the strike
price), on or before the expiration date of the option.
This strategy has several great benefits.
If the asset price is above the exercise price at
expiration, the puts will not be exercised and you just
pocket the option premium. You can do this over and over
again and may never get the asset "put" to you if the asset
is above the exercise price at expiration of the option.
This generates continuous income for you, increasing your
portfolio and generating cash flow for other investments.
If the puts you sold do get exercised, then you are
obligated to purchase the asset at the exercise price. But
you essentially get it at a discount. You have already
agreed that you would like to purchase the quality asset at
the exercise price and the price is further discounted by
the option premium that you collected.
If the asset does get put to you, you could then also sell
covered calls on it to reduce your basis in the asset even
further.
Since you are the seller of the put, the time decay of the
option works in your favor. The time-value portion of the
put premium constantly declines with time, going to zero on
the expiration date. The rate of decay is predictable and
is easily calculated by options analysis programs such as
Option-Aid. As the expiration date approaches, the rate of
decay increases. For this reason, it is often better to
sell puts with one month or less until expiration. After
they expire, you can sell puts on the next month out and
collect another premium.
When you make your asset selection, it helps to pick an
asset that has started into an uptrend, to increase the
premium that you collect when you sell the put and reduce
the likelihood of the put being exercised.
It is also important to cover the risks and caveats of this
strategy. Your broker will impose a margin requirement on
you when you are selling puts, for insurance against a
decrease in the price of the underlying asset. So there is
some lost opportunity cost here because that money could be
working for you elsewhere. If the price of the asset moves
downward instead of upward as you anticipated, then the
dollar value of the margin requirement will increase, but
it will never get higher than the purchase price of the
stock if it is put to you.
If you are thinking about purchasing an asset anyway, this
strategy can be used to purchase the asset at a discount,
or generate income for you as you stand ready to purchase
the asset at a discount.
When you are analyzing potential option positions, it
helps to have a computer program like Option-Aid that
swiftly calculates volatility impacts, probabilities,
statistics, and other parameters of interest. These
programs can pay for themselves with the first trade that
they help you with.
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