The sale of put options can be an excellent way to gain exposure to a stock on which you are bullish with the added benefit of potentially owning the stock at a future date at a price below the current market price.
To understand how selling puts may benefit your investment strategy, a quick primer on options may be helpful to some. In this article, we'll look at a typical put selling strategy as well as the potential risks and rewards involved. Very simply, an equity option is a derivative security that acquires its value from the underlying stock it covers.
Owning a call option gives you the right to buy a stock at a predetermined price, known as the option exercise price. A put option gives the owner the right to sell the underlying stock at the option exercise price. Thus, buying a call option is a bullish bet - you make money when the stock goes up - while a put option is a bearish bet because if the stock price declines below the put's exercise price, you can still sell the stock at the higher exercise price. The exact opposite view is taken when you sell a call or put option.
Most important, when you sell an option you are taking on an obligation not a right. Once you sell an option, you are committing to honoring your position if indeed the buyer of the option you sold to decides to exercise. Here's a summary breakdown of buying versus selling options. Since selling a put puts you in an obligatory position of taking ownership of a stock, the first important rule of put selling is revealed: In addition, you should only enter into such a trade where the net price paid for the underlying security is an attractive price.
This is by far the most important consideration if one wants to sell puts successfully during any market environment. There are other reasons to sell a put, such as when you are executing more complex options strategies, learn more in Iron Condors Fly On Fragile Wings and Advanced Option Trading: The Modified Butterfly Spread.
Once this rule is satisfied, then the other benefits of put selling can be exploited. One benefit is the ability to generate income on your portfolio. If the sold put expires without exercise, the seller keeps the entire premium.
Another key benefit is the ability to own the underlying stock for a price below the current market price. An example will better illustrate both the benefits and potential risks when selling a put. Consider shares in Company A, which continues to dazzle investors with increasing profits from its revolutionary products.
That's not a bad valuation for the growth this company has produced. So, you collect the option premium and wait. Learn more about put option strategies in Bear Put Spreads: Learn how to "wait for the slow pitch" from veteran options trader Luke Downey in Investopedia Academy's Options for Beginners course. You can see why it's prudent to sell puts on stocks you would love to own.
If you don't have that cash in your portfolio, your broker can force you to sell other stocks in order to buy this position. One risk in a an opportunity cost sense is that Company A shares continue to appreciate. In the end, utilizing the sale of put options can be a very prudent way of generating additional portfolio income.
You also get exposure to the stocks you would like to own, but want to limit your initial capital investment. You forgo additional upside of course, but if you sell a put and the stock price goes up, you are making money, so all is good. As long as the underlying stocks are of companies you are happy to own, put selling can be a lucrative strategy.
Dictionary Term Of The Day. A reduction in the ownership percentage of a share of stock caused by the issuance Broker Reviews Find the best broker for your trading or investing needs See Reviews.
Sophisticated content for financial advisors around investment strategies, industry trends, and advisor education. A celebration of the most influential advisors and their contributions to critical conversations on finance. Become a day trader. Put Options Very simply, an equity option is a derivative security that acquires its value from the underlying stock it covers.
Buying a Call - You have the right to buy a stock at a predetermined price. Selling a Call - You have an obligation to deliver the stock at a predetermined price to the option buyer. Buying a Put - You have the right to sell a stock at a predetermined price. Selling a Put - You have an obligation to buy the stock at a predetermined price if the buyer of the put option wants to sell it to you. Characteristics of Prudent Put Selling Since selling a put puts you in an obligatory position of taking ownership of a stock, the first important rule of put selling is revealed: Put Selling In Practice An example will better illustrate both the benefits and potential risks when selling a put.
Put Selling Risks You can see why it's prudent to sell puts on stocks you would love to own. The Bottom Line In the end, utilizing the sale of put options can be a very prudent way of generating additional portfolio income. A reduction in the ownership percentage of a share of stock caused by the issuance of new stock.
Dilution can also occur A conflict of interest inherent in any relationship where one party is expected to act in another's best interests. Passive investing is an investment strategy that limits buying and selling actions. Passive investors will purchase investments How much a fixed asset is worth at the end of its lease, or at the end of its useful life. If you lease a car for three years, No thanks, I prefer not making money. Get Free Newsletters Newsletters.More...