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3 Steps to Effectively Sell Put Options

If you’re looking to generate additional portfolio income, consider selling put options. Not only can this strategy provide you with extra income, but selling put options also gives you the opportunity to enter equity positions. In addition, understanding the selling process helps you make wiser financial decisions going forward. Learn more about selling put options, how to sell puts, and when to sell puts to gain the most benefits.

  • When you sell a put option, you agree to purchase an underlying stock at an agreed-upon price within a specific time frame.
  • Selling puts allows you to generate portfolio income, lets you potentially own an underlying security, and provides you with portfolio protection.
  • Only sell puts when you believe an underlying share appears to be undervalued.
  • Only sell put options if you’re comfortable owning the underlying security at the predetermined price since you’re obligated to buy if the other party exercises their put option.

What Does It Mean to Sell Put Options?

Image via Unsplash by Markus Spiske

Put options refer to contracts that give the owner of the put the right to sell or short sell a certain amount of an underlying security at an agreed-upon price within a specific time frame. If a put buyer exercises their put option, you, as the seller, must buy the asset. In other words, you’re obligated to buy the security from the option buyer at a preset price if they choose to exercise their option.

When you sell a put option, it means you’re willing to purchase a stock at the current price because you have a feeling the price will increase later on.  Essentially, selling a put option allows you to implement options into your investment strategy.

If the stock rises above the strike by the expiration date, you’ll make money. Despite this, you can’t multiply your money like you would if you were to buy a put. Instead, you have a capped profit set at the premium you received upfront.

Call Vs. Put Options

Call options give a trader the choice to buy an underlying asset at an predetermined price by a specific date. If a trader sells a call, they must deliver the option if the buyer decides to exercise their right to the option. With this bullish beat, the owner makes a profit when the security rises.

In contrast, a put option refers to a contract that gives the owner the chance to sell an underlying asset at a predetermined price. When traders sell a put, they’re obligated to purchase the security at the agreed-upon price from the option buyer if they exercise the option. Overall, this bearish bet allows the owner to make a profit when the security falls.

It’s common for traders to use strategies that involve both call and put options to spread out their risk.

Why Should You Sell a Put Option?

Selling a put option comes with several advantages for investors:

  • Ability to generate portfolio income: Selling put options lets you keep the entire premium if the sold put expires without the counterparty taking action. You can generate both income and returns in various market environments including flat, bearish, or overvalued markets. In addition, you get cash upfront and may never have to buy the stock at the strike price. Overall, selling puts allows you to generate high returns even when the stock prices fall or remain flat.
  • Portfolio protection: When you sell put options, you can provide your portfolio with 10% or more downside protection when a market crash occurs. Let’s say the market drops 35%. If this were to happen, your equity positions would only drop down to 25% thanks to that 10% cushion.
  • Ownership of the underlying security: When you sell put options, you gain the ability to potentially own the underlying stock at a future date and at a better price point. Essentially, selling put options lets you gain bullish exposure while also giving you the chance to possibly own the underlying security later on and at a price that’s lower than its current market price.
  • Lower costs: When you sell put options, you can enter stock positions at prices that are favorable to you. This process allows you to keep your costs low when you buy during price falls, giving you a better value than if you purchased it at the current market price.

Although selling puts presents various benefits for investors, it’s also important to take into account the risks you face with this strategy. Overall, selling put options puts you at risk of losing money if the stock price falls. This is because you have to purchase the stock at the strike price while only being able to sell it at a lower price.

To clarify, the strike price refers to the predetermined price the put option buyer can sell at. So if the stock takes a massive hit and suddenly plummets, you have to buy it at that much higher strike price. To do this, you need to have enough cash to cover the cost of the stock in your brokerage account.

When to Sell Puts

B efore you decide to sell a put option, be patient and understand both the long-term risks and rewards. Doing so allows you to gain more success from this strategy. Only sell a put if you believe the underlying stock will rise. Ideally, aim for anywhere from 30-45 days from the expiration to gain a solid profit. This time frame allows you to benefit from accelerating time decay on the option’s price as the expiration draws near. In addition, it’s important that the stock price is slightly lower than the strike price and stays there until expiration.

3 Steps to Effectively Sell Put Options

To make money by selling puts, you need to write several put options for stocks that you believe will increase in value. The hope is that the fees you collect offset any losses you incur when stock prices drop. Focus on selling put options on stocks that you want to own and view as undervalued. Here are the three simple steps for how to sell puts:

  1. Find an underlying stock that you think is on the rise, is undervalued, and provides good downside support.
  2. Select a strike price that you think is achievable by the option expiration date.
  3. Sell only the amount of contracts you’re comfortable having exercised.

Selling Put Option Strategies

While options can be pretty risky, they don’t have to be. Aim to use them in a way that minimizes your risks while allowing for a profit based on the rise or fall of a stock. Here are some additional put-selling strategies and tips to consider to help you receive the most benefits:

  • If you want to make a profit in any market environment, only enter trades when the net price paid for the underlying security seems desirable.
  • Consider choosing the first strike price below the current market price to increase the chances of the put being assigned.
  • Although higher premiums may seem desirable, they don’t always translate into higher profits. While they often lead to higher expected volatility, any declines could put you in a severe losing position.

Ultimately, selling put options provides you with a flexible way of generating income and entering stock positions. Now that you understand how to sell a put option, consider using this strategy to retain a desirable profit. Keep in mind that I’m not a broker or advisor, so it’s helpful to continue reading and learning about selling puts to find the best strategy for you.