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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