Answers to the Top 5 FAQs on Selling Put Options
One common misconception regarding trading and investment is the idea that investors are at the mercy of the stock market when it comes to pricing. In reality, investors can exercise greater control over the price they pay for assets by taking advantage of stock market instruments like put options. You can use put options to your benefit to make your portfolio more profitable.
To empower you to get the stocks you want at the price you’re willing to pay, we’ve answered the top five frequently asked questions on selling put options. While we’re not stockbrokers or advisors, we hope the information provided here gives you the tools you need to inform and enhance your trading strategies.
Top 5 FAQs on selling put options:
Image via Flickr by scootergenius02
A put option is a contract with the option to sell assets at an agreed upon price by a specified date. The parties involved in this transaction are the seller or the writer and the counter party, which is the party purchasing the put.
There are three parts to this transaction:
By selling put options, an investor can name the strike price at which they’d be willing to purchase the asset. The counter party then pays the investor a premium to wait for the stock to hit the strike price. There are several steps to this process:
It’s important to note that by buying a put option, the counter party is purchasing the right to sell their asset to the option writer. They are not obligated to sell the asset to the writer. The good news is, before the counter party exercises the option, investors can buy to close the option at any time. Based on how the stock has done since the put option, investors may make money, lose money, or break even.
Keep in mind that as an option seller, time is always working to your advantage. Because premiums decline in value over time, if all other factors remain neutral, you can usually buy back your option for less than you sold it.
Many investors go their whole lives without dabbling in put options. With all there is to learn about the process and the risks involved, selling puts isn’t for everyone. However, if this sounds like a strategy you’re interested in taking advantage of, it’s important to know when selling put options could benefit your portfolio.
Let’s say you’re looking to collect on large premiums. In this scenario, the best time to sell puts, for example, is when stocks you’re interested in are undervalued. This will result in optimal price levels if the put is exercised by the counter party.
However, if you’re solely looking to collect premiums, there’s a certain amount of risk involved. For this reason, there are two general rules of thumb to take into account in deciding when and if to sell put options:
Chances are, when the expiration date approaches, the counter party will exercise the put. You should always plan for this outcome.
To ensure you only take on assets you want, you should only set put options for stocks you’re really willing to add to your portfolio. This makes selling put options a win-win for the participating investor.
Assuming that the counter party will exercise the put by the expiration date, you have to have the funds available to uphold your side of the bargain. This can be tricky, because while both parties agree to a strike price, if this price is exceeded before the expiration, the seller remains committed to purchasing the agreed-upon asset. For this reason, you should only sell as many put options as you have the funds to afford. To play on the safe side, you should keep your strike price well within your means.
There’s no right or wrong way to select your optimal strike price. The key is to choose the most competitive strike without exceeding the price the stock will reach on the date of its expiration. This is obviously difficult because when you’re determining your strike price, the stock’s impending value is unknown.
Puts with high strike prices, called out-of-the-money puts, are the more likely of the two to expire before the put can be exercised by its buyer. This results in the put being worthless. Puts with low strike prices however, called in-the-money puts, serve as realistic proxies for impending ownership of the share. For this reason, while higher strike prices are considered the best-case scenario for the investor selling the option, the gain can be significantly less than that achieved by a lower strike price and the resulting share ownership.
Maximum gains on put options with in-the-money strike prices equate to 100% of the upfront premium paid to the put seller and also provide a margin of safety relative to the trade’s initial value.
Selling put options is called a ‘naked strategy.’ This means that the seller doesn’t yet own the asset’s underlying security and is therefore exposing themselves to the risk that comes of working with an unknown security position.
To clarify, an underlying security is the factor on which an option’s value is based. A security can take the form of a stock, bond, index, commodity, interest rate, or even currency. Futures, exchange traded funds (ETFs), and other derivative instruments also possess underlying securities that determine their price and value.
Because securities can hypothetically rise infinitely, the naked strategy of put options can have detrimental consequences when not exercised wisely. However, while unpredictable, put options are a bold move that can really pay off when exercised as part of a diversified portfolio.
The first benefit is the obvious one. Selling, or writing, a put option gives you the opportunity to purchase the option’s underlying security at a later date for your desired price.
By selling a put option, the investor agrees to the specifics of a sale with the counter party in advance, so when the time comes and the put is exercised, the only thing left to do is reap the benefits.
In addition, if the expiration date arrives and the counter party chooses not to exercise the sold put — in other words, not to sell the asset — the investor gets to keep the entire premium. In this way, by selling put options in securities you already have your eye on and are interested in owning, you open yourself up to the possibility of generating free portfolio income and ultimately being more profitable.
B y selling a put option, you are committing to purchasing an asset should the counter party choose to sell it to you. By buying a put option, the counter party is paying you to decrease your purchasing flexibility.
It’s like going all in before the flop in a game of poker. Everyone has the opportunity to benefit, as long as they’ve thought long and hard about the risks before putting their chips down.
The world of buying and selling put options is daunting, with a lot of different variables coming into play and affecting the lucrativeness of the outcome. Armed with the answers to these frequently asked questions, you know that the price you pay to invest in a company doesn’t have to be determined by the market. Sell put options to name your own price and get paid to wait until that price becomes available.
Top 8 Option Stock Brokers
Options trading is an area of investment that allows investors to buy and sell indexes, ETFs, and securities at a predetermined price for a specific period of time. During that time, options’ values fluctuate based on the price of the option’s underlying instrument. For this reason, options trading can be high-risk, but it can also offer unique benefits from trading ETFs or stocks on their own. For investors willing to brave options trading for the potential for high reward, there are a lot of online option brokers available to support you.
Each online option trading platform is distinctive, making it important to understand your needs and the best options trading strategies for your portfolio. While we’re not a stockbroker or advisor, it’s important to have a thorough knowledge of the choices available to you in order to find and identify possible trades for yourself. Here we’ve analyzed high-visibility options brokers based on qualities important to users such as account minimums, thorough research, trading commissions, and account bonuses, and compiled a list of the top eight option stock brokers:
Image via Flickr by CreditDebitPro
TradeStation is a discount option broker that caters to active traders, futures trading, and low-cost trading. With a powerful platform and competitive commission prices, TradeStation is the perfect broker for online options trades if you’re a frequent trader. While this broker has a $0 minimum balance, investors who keep at least $2,000 in their account will avoid any account inactivity fees.
Those willing to compare pricing on both of TradeStation’s commission schedules can spend less than they would on other platforms. TradeStation also offers options commissions as low as $0.50 per contract, based on the user’s chosen account type. Keep in mind that TradeStation does not offer features such as research and fee-free mutual funds. They also don’t possess any no-transaction-fee mutual funds. If these are important to you, consider one of the other online option brokers mentioned here.
Interactive Brokers (IBKR) is another low-cost choice among online trading options platforms with premium features that cater to professionals. With more outstanding margin loans than any other discount broker, low margin rates are a large plus of the Interactive Brokers platform. In addition, IBKR boasts an average client trade rate of over 300 times per year, meaning the typical user is an active trader, financial professional, or experienced investor. For this reason, Interactive Brokers offers its research at an additional charge.
If you consider yourself to be a less active trader, Interactive Brokers also offers a no-commission IBKR Lite Plan. Interactive Brokers does have a minimum monthly fee of $10, however, those on the IBKR Pro plan can avoid this by sustaining a balance of $100,000 or more. Interactive Brokers has an options commission of $0.65 per contract, with volume discounts available.
As a full-service online broker, Charles Schwab is one of the best overall picks. This option stock broker features essential research investors need to make educated trading decisions, fair pricing on options, incredible customer support, and an impressive StreetSmart Edge trading platform. With Amazon’s Alexa, you can also use Schwab to request quotes, organize your watch list, and get market updates. Charles Schwab offers an options commission of $0.65 per contract.
Similar to Schwab but with even more research tools for investors, Fidelity is an online trading options broker that’s great for beginning investors. Fidelity boasts over 3,500 no-transaction-fee mutual funds and $0 trading commissions. It also has zero-fee index funds. One of our favorite parts of this choice for option trading online is that, unlike many other brokers, Fidelity doesn’t nickel and dime investors. They also have a strong customer experience reputation, and their Active Trader Pro platform is top notch. Fidelity’s options commissions are $0.65 per contract.
With first-rate tools and products, TD Ameritrade is a competitive platform for trading options online. TD Ameritrade users have access to over 1,900 no-transaction-fee mutual funds and commission-free ETFs, making this a preferred choice among investors who frequently use funds. Among discount brokers, this stock options broker boasts one of the farthest-reaching branch networks and most extensive research offerings, greatly benefiting users who value a local branch office with access to in-person customer service or who desire more guidance.
Keep in mind that among discount brokers, TD Ameritrade’s margin rates are relatively high, costing up to $475 a year even on a moderate $5,000 average daily balance. If your investment strategy focuses on margin, consider one of the other online trading options listed here.
TD Ameritrade supports $0 commissions and has no account minimums.
Geared toward long-term investors, Ally invest is an easy-to-use, web-based stock options broker. With a no-load mutual funds fee of $9.95, investors who rely on mutual funds can keep all of their investments in one place, a relatively low cost for the benefits provided. In addition to its simple interface, Ally Invest has 24/7 phone and online chat support. This platform features $0 commissions and no account minimums. Their options fees are $0.50 per contract, making this an excellent choice for price-aware investors.
Note that Ally Invest charges more for commission on stocks priced lower than $2. If you identify as a penny stock trader, one of the other options online brokers mentioned here may better suit your needs.
When it comes to low costs, cash management, and fractional shares, this no-fee brokerage is an ideal platform for newer investors looking to trade options online. On Robinhood, users are treated to a highly competitive annual percentage yield (APY) on uninvested money and can buy fractional stock shares priced as low as $1, making it a super sweet deal for investors with limited funds. Similar to Ally Invest, Robinhood showcases a comparatively simple interface with fewer features but greater ease of use.
In addition to options, investors can trade stocks and ETFs, but it is important to note that Robinhood doesn’t support the trading of mutual funds or bonds on their platform. If these are key to your portfolio, another broker may serve as a better option online trading choice for you. Those who need more than the standard brokerage account, including trusts, partnerships, custodials, and IRAs, should also look elsewhere.
For $5 a month, Robinhood also offers a premium product, Robinhood Gold, which provides its users with access to larger deposits, Morningstar stock research reports, and margin trading.
E*TRADE is a U.S. options broker with tools and resources that meet the needs of every kind of investor. Its free and convenient online Power E*TRADE platform is particularly popular among options traders, especially those with multiple trading platforms. E*TRADE also offers thousands of free-to-trade ETFs and mutual funds for long-term investors.
Note that some mutual funds made available through this service may have their own minimum investment requirements, but investors can easily build a diversified portfolio from the 4,400 available no-transaction-fee funds. Both standard brokerage accounts and IRAs on E*TRADE have no minimum deposit requirements.
E*TRADE provides 24/7 phone and online chat support and has several brick-and-mortar branches, giving nearby investors the opportunity for in-person customer service.
Now you know the top eight option stock brokers, but which is the best choice for you? When choosing investment tools, we like to take into account three factors:
Once you’ve selected the options online trading platform that suits your needs, you’ll be able to set up your option trading account and get started.
Why So Many Investors Feel the Stock Market Is Rigged
T erms such as ‘liquidity crisis,’ ‘recession,’ ‘mortgage-backed securities,’ and ‘over-leveraged’ became popular topics of discussion during the 2008-2009 financial crisis. New-to-the-market investors were left wondering about stock market rigging, while many veteran investors got burned one too many times by a greedy elite at the expense of the general investing population. Most, if not all, investors were left wondering whether the stock market is rigged.
Image via Flickr by lendingmemo_com
Technically, the stock market is not rigged. However, there are real disadvantages that investors, especially small investors, will need to overcome to be successful in the stock market. Understanding where information is coming from and strategies for successful investing can help investors overcome perceived stock market rigging.
Despite what appears to be an endless amount of stock and financial data available online, the average investor isn’t usually skilled in technical analysis. They also don’t typically have access to in-house research analysts, technical experts, or sophisticated automated trading programs providing trading suggestions.
One of the most significant informational barriers the average investor experiences is the actual timing in which they receive information. While the internet acts somewhat as an equalizing factor, the reality is that most institutional investors have this information before the general investor does.
Probably the largest disadvantage the average investor faces is capital. Consider this non-market example: You are the owner of a small office supply store looking to purchase a large order of paper products for resale. You call your distributor to inquire about pricing. Costco also calls this distributor saying they want the same paper product order for each of their thousands of stores worldwide. Costco will have more pricing power with the distributor than your small office supply store and will probably receive more favorable pricing.
To a lesser extent, the same can be said when purchasing and selling securities. Larger investors can often negotiate lower prices on fees and commissions compared to everyday investors. Also, average investors don’t have the same opportunities to subscribe to IPOs that institutionalized investors do.
Hot IPOs are usually reserved for larger, preferred investors such as pension funds, hedge funds, and individuals having an extremely high net worth. Only after preferred clients have been given the opportunity to subscribe will the IPO be available to the average investor. At that point, investors with small accounts need to consider if investing in an IPO opportunity larger investors already passed on is a good idea.
Despite the harsh criticism many politicians have toward financial institutions during a financial crisis, the relationship between these two groups is significant. Most individual investors don’t have direct access to elected governmental officials or paid lobbyists to watch over their interests. The average investor also isn’t invited for a seat at the table when politicians are considering and writing new laws.
While intimidating, these apparent disadvantages shouldn’t dissuade the average investor from reaching their goals. Careful monitoring of investments, mitigating risks, and staying informed of general investment trends and themes can assist investors in overcoming these imbalances and finding some success in the market.
W hile the barriers noted above are real, there are ways to work around perceived stock market rigging or, at the very least, increase awareness of the system and how it works. Doing so does require effort on the part of the investor.
The internet has become an information equalizer for average investors. Financial-based websites can assist everyday investors in making sense of the financial market world. Taking an hour or two each week to look over business trends and news, such as reading readily available profiles and research reports on sites such as CBS Market Watch and Yahoo! Finance, can increase the information small investors have available to them. Other tips for mitigating what appear to be rigged markets include:
According to a study, during the 30-year period between 1983 and 2013, a large portion of stock price increases happened on just 10 trading days. Investors who weren’t in the market during these specific 10 days saw a decrease of 2.6% in their returns for this 30-year period. The best way to prevent this decline? Never sell. Staying fully invested in the stock market until long-term financial goals, such as retirement, are met is one way to try to beat the odds of the stock market.
No one truly knows with complete confidence if the price of oil is going to drop over the next four months or if the jobs report for next month will be better than the one before. In all reality, the world is just too complicated to know with absolute certainty which direction stocks, oil, or the labor market will head in the short-term. However, in looking at the stock market over time, the one consistent theme time after time is that stocks generally improve and beat inflation.
Buying stock index funds, especially those traded on exchanges, is one of the best ways to benefit from long-term rewards of the stock market. These low-fee, passively managed funds are investments looking to match the returns of the stock market. They also provide diversification and additional security for new investors, who are often tempted to disregard the benefits of long-term investing and sell during downward trends in the market.
After investors become comfortable with indexing, they can take advantage of retail stocks by allocating a small percentage of their funds to a retail sector ETF (exchange-traded fund). This type of ETF acts as a retailer stock index, helping investors outpace the stock market as a whole.
For example, the SPDR S&P Retail ETF, seeking to match S&P Retail Select Industry Index returns, as a whole outperformed the SPDR S&P 500 ETF, mimicking the S&P 500 Index for the majority of the 10 years ending in July 2019.
This easy, one-two indexing punch is an ideal plan for most investors. For those believing they have the temperament to hang on to individual retail stocks during a sell-off, then purchasing a couple may be a smart investment. However, the majority of investors find sticking with a long-term investment strategy easier with a diversified portfolio that includes index funds.
It’s almost always a bad idea to try to time the stock market. However, as long as an investor isn’t looking to time their way ‘out of the market,’ adding to a position when the market sharply pulls back may be beneficial. For investors who never sell, sticking to index funds and simply purchasing more when the market declines should bring about positive market returns.
Dollar-cost averaging with index funds each month, rain or shine, is a good strategy. This way, when the stock market pulls back 15% in a month, regular contributions will purchase more shares at a decreased cost, decreasing the average cost paid for the investment.
It’s important that investors recognize and appreciate the benefits they receive when buying on declines, but not obsess over what their money is doing until they’re closer to meeting their long-term financial goal or retirement.
The stock market technically isn’t rigged for the everyday investor. Governing bodies like the SEC (Securities and Exchange Commission) exist as a way to level the playing field for average investors. However, it’s hard to overlook the apparent advantages Wall Street money managers continue to have. The best thing an average investor can do is take advantage of any available resources they have at their disposal.