This means that in periods of high volatility, especially on moves to the downside, option sellers receive higher than normal premiums. If you were thinking of buying the stock anyway, selling out of the money puts can be a less expensive way to go about it. If the stock continues to decline through the strike price of the put you sold, the option will end up in the money at expiration and you will be obligated to buy the stock at the strike price. Your net price on the purchase will be the strike price minus the premium you collected on the sale.
Because the put was out of the money when you sold it it has a strike lower than the current stock price your basis for the purchase will be lower than the market price for the stock was when you initiated the option trade — effectively a discount.
Some notes on this trade: Earnings announcements Be careful about selling options right before or after quarterly earnings announcements in the stock. Implied volatilities especially in short dated options tend to rise going into a scheduled announcement because of the potential of a surprise beat or miss to move the stock quickly.
Volatilities will then decline sharply after results are announced and any resulting move in the stock happens. If you sell a put right after earnings, the stock decline has likely already happened and the premium you receive will be lower.
Risk and Margin Because of the risk involved, brokerage houses generally require that you have available cash or margin in your account to complete the purchase of the stock in the event that the option ends in the money and you are assigned. You will need to square this away before you trade.
Want to apply this winning option strategy and others to your trading? Then be sure to check out our Zacks Options Trader service. Want more articles from this author? Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report Netflix, Inc.
Key Takeaways Selling options can be a consistent way to generate excess income for a trader, but writing naked options can also be extremely risky if the market moves against you.
Writing naked calls or puts can return the entire premium collected by the seller of the option, but only if the contract expires worthless. Covered call writing is another options selling strategy that involves selling options against an existing long position. Compare Accounts. The offers that appear in this table are from partnerships from which Investopedia receives compensation. This compensation may impact how and where listings appear.
Investopedia does not include all offers available in the marketplace. Related Articles. Partner Links. Related Terms Options Contract Definition An options contract gives the holder the right to buy or sell an underlying security at a predetermined price, known as the strike price.
What Is an Outright Option? An outright option is an option that is bought or sold individually, and is not part of a multi-leg options trade. Put Option Definition A put option grants the right to the owner to sell some amount of the underlying security at a specified price, on or before the option expires. What Is a Long Position? A long position conveys bullish intent as an investor will purchase the security with the hope that it will increase in value.
Ratio Call Write Definition A ratio call write is an options strategy where more call options are written than the amount of underlying shares owned. What Is Capping? Capping is the practice of selling large amounts of a commodity or security close to the option's expiry date to prevent a rise in market price. They are happy to buy the stock at the current price because they believe it will rise again in the future.
Since the buyer of the put pays them the fee, they buy the stock at a discount. Put options are used for commodities as well as stocks.
Commodities are tangible things like gold, oil, and agricultural products, including wheat, corn, and pork bellies. Unlike stocks, commodities aren't bought and sold outright. No investor or trader purchases and takes ownership of a "pork belly. Instead, commodities are bought as futures contracts.
These contracts are hazardous because they can expose you to unlimited losses. Unlike stocks, you can't buy just one ounce of gold. A single gold contract is worth ounces of gold. Since the contract is in the future, you could lose hundreds or thousands of dollars by the time the contract comes due. Put options are used in commodities trading because they are a lower-risk way to get involved in these risky commodities futures contracts.
In commodities, a put option gives you the option to sell a futures contract on the underlying commodity. When you buy a put option, your risk is limited to the price you pay for the put option premium plus any commissions and fees.
Even with the reduced risk, most traders don't exercise the put option. Instead, they close it before it expires. They use it for insurance to protect against loss. If a put option expires before it is exercised, it essentially disappears. The brokerage will remove that option from the account of the person who bought the put. The person who sold the put no longer has to worry about maintaining the buying power to purchase the shares. When you exercise a put option, you sell shares at the option's strike price.
Keep in mind, you must have those shares to sell them. If you don't own them before exercising the option, then you'll need the buying power to cover that purchase—even though you may only own the shares for a matter of minutes. If you sold the put to open the trade, then you will buy the put at the current market price to close it. Select basic ads. Create a personalised ads profile. Select personalised ads.
Apply market research to generate audience insights. Measure content performance. Develop and improve products. List of Partners vendors. Selling also called writing a put option allows an investor to potentially own the underlying security at a future date and at a much more favorable price.
In other words, the sale of put options allows market players to gain bullish exposure, with the added benefit of potentially owning the underlying security at a future date and at a price below the current market price. A quick primer on options may be helpful in understanding how writing selling puts can benefit your investment strategy, so let's examine a typical trading scenario, as well as some potential risks and rewards. An equity option is a derivative instrument that acquires its value from the underlying security.
Buying a call option gives the holder the right to own the security at a predetermined price, known as the option exercise price. Conversely, buying a put option gives the owner the right to sell the underlying security at the option exercise price.
Thus, buying a call option is a bullish bet—the owner makes money when the security goes up. On the other hand, a put option is a bearish bet—the owner makes money when the security goes down. Selling a call or put option flips over this directional logic. More importantly, the writer takes on an obligation to the counterparty when selling an option; the sale carries a commitment to honor the position if the buyer of the option decides to exercise their right to own the security outright.
Here's a summary breakdown of buying vs.
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