Selling Put Options - Get Paid to Wait

How To Profit from Selling PUT Options?


In a bear market situation, no one should bottom fish. But sometimes, for most of us, having cash idling almost feels sinful.

Do you want to get paid for your cash idling in your trading account while waiting for your target buy price to be reached?

Then, perhaps you should consider SELLing Puts options!

There are several good reasons for Selling Puts.

1) You are being paid to wait for price to reach your intended buying price
2) You pay a lower price for a stock that you wish to add to your account
3) You stay disciplined in not "chasing" after price rallies and get rewarded

To understand the above, one needs to understand what Selling of Put options entails.

In a gist, selling or known as WRITING a Put option is an act of undertaking an obligation to purchase the underlying stock at a predetermined price. See option chain on Citibank as an example.

Suppose, you WRITE 1 contract (equivalent to 100 shares) of Citi $15 Put Strike Price to expire in Sept08, then you will receive $0.45 credit or $45 (100 x 0.45) into your trading account.

The 4 scenarios that can happen by Sept08 expiration are as follows :

Scenario #1 - C Price Remains Roughly Unchanged
Since C price is above $15, then you will keep all of the $45 premium.
Static return is 45/1500 = 3% (there are only 36 days to expiration) or 30.4% annualized (3% x 365 / 36)
The reason I chose $1500 as the denominator is because this should be the money you should have in your account, standing by and ready to purchase C at $15. While this amount is not actually utilized, it should not be redeployed or else a margin call can occur, if C price tanks drastically. In actual fact, your brokerage will not require you to post 100% as margin. But it is always safer to ensure you do not bet using money you do not have.

Scenario #2 - C Price Rallies
Since C price rallies, your WRITE Put option will never be exercised. Similar to scenario #1, you keep all of the premium credited into your account.

Scenario #3 - C Price Drops Modestly
If C price drops but stay in this range $17.81 > C > $15, again this Put option that you sold, will expire worthless and again you keep all of the $45; ie 30.4% annualized returns.

Scenario #4 - C Price Tanks Below $15
Suppose C price drops very quickly and even before expiration date, C price went well below $15. What happens then. It is very likely you will be assigned 100 shares of C at $15. Why? The reason is because, when you WRITE 1 C Sep08 15 Put, you have assumed the obligation to be assigned (BUY) 100 shares of C at $15 from someone who LONG that C Sep 15 Put. That person has a right to sell to you 100 shares of C at $15 as and when he chooses to do so. Remember that in american style options, assignments can be done at any time before and up to expiration date.
Since now C has dropped well below $15, obviously, he will sell you 100 shares of C at $15 and goes to the exchange and buys C at a lower price, hence making a profit from the differential.
Does this then sound silly? The answer is NO. The reason is simply because you had wanted to purchase C only at $15 originally and not any higher. Now that C has come down to your price target, why would you lament about being a proud owner of C at $15? In fact, you are[/] not [b]paying $15 but actually $15 - $0.45 = $14.55 or a total of $1455 for 100 shares of C. This is a discounted price!

Hence, in WRITING Put option, the 1st premise MUST be that you already had the intention of purchasing that 100 shares of C at $15. If you do not have such an intention, then you should not be writing that Put option.

The Probability of Success
In 3 of 4 scenarios described above, you make a 30.4% annualized return. This strategy offers a 75% chance of success ! Isn't this a good strategy? It is, if you know exactly what you are doing.

The Icing on the Cake
Now that you are a proud owner of 100 shares of C, what next?
Refer to my earlier post on Covered Call Writing; ie, you can begin Writing Covered Call on your 100 shares of C....and should your Covered Call be exercised, meaning you have to deliver those 100 shares of C, this is a happy "problem". Remember that if you 100 shares of C are "called away", it only means that C price has moved up. You have C shares and it can only mean profits for you if C price rallies. The "if-called" return is always very good return on investment. If your Write Covered Call is not exercised, then you simply keep the premium. You win again.
Repeat WRITE Put Strategy detailed in this post and when you should be assigned again, repeat the Covered Call strategy once again. Do this exercise repeatedly.

If you stay disciplined and choose the correct Strike Price, Expiration Month, understand the Greeks and Implied Volatility, you will be a successful investor of your money in the long run.

The biggest misconception about Options Trading is that it is all about Long Call and Long Put. It is not. The most successful investors combine both stocks and options to maximise their capital.

I wish you success and HUat HUat !!!!