Did you know that selling put options is a great way to generate income? Note that I said sell put options, not buy them! The reality is, you can use this strategy to generate a consistent income flow.
In fact, I look forward to the 3rd week of every month when my put options expire worthless. Yes, you heard right, worthless. And no, I’m not crazy.
Do you want to know how to sell put options that will earn you at least 1% of your portfolio value? I’ll take that as YES. So without further ado, here are some of the reasons why I love selling put options.
- Here’s how to sell put options:
- Log into broker
- Click on trade tab
- Go to put chart
- Click on sell instead of buy
Before we get into how to sell put options, let’s start with the basics. What are options?
As a result, you can trade the large cap stocks without putting out the capital. That’s a fantastic way to grow a small account without having to go into penny stocks.
Options have a lot of moving parts which affect profit and loss. Learning how to sell put options means you need to learn how those different parts work.
Does time hurt you or help you? How does implied volatility work in your favor? What about the rest of the Greeks?
You Can Be Wrong
Sounds like half the decisions I’ve made in my life. Regardless, no one can be perfect all the time and better yet, you don’t have to be 100% right on an options trade to make money if you know how to sell put options.
Let’s take Intel (INTC) for example. You think the price has hit bottom so you buy it today at $22 a share with the hope that the price goes up in the near future so you can sell and make money. A kinda simple concept – buy low sell high, no explanation necessary.
The problem here is that you’ve tied up your capital and at $22 a share that could mean a lot of capital. Now comes the second problem, you’re at the mercy of the tides of the market.
And we all know how finicky they can be. You hope you bought the dip, and the price won’t drop another say, 10% for example.
Unfortunately, if it does drop, you have no choice but to sell at a loss because you are a wise trader and follow proper risk management strategies.
On the other hand, if you sold a January 2019 $20 put option for $0.40 a contract, your effective entry price is $19.60. Because of this you now have a 10% downside protection until January 19th, 2019.
Even if your analysis was completely left of center and the stock tanks to $18, you’re ok. This is because you can always roll forward and down your put option to, say, April 2019 and still make a profit from the trade.
Do I have your attention yet? Once you’ve entered into the position, you don’t need to do too much. Other than checking the price of the underlying stock once or twice a day you’re free to hit the beach, gym, or do what your heart desires.
When enough time has passed, or the market has moved in your favor, you simply buy back your put contract and free up your capital. Then you simply use your capital by selling put contracts on another stock.
This rinse and repeat cycle can be done over and over. Knowing how to sell put options allows you to be a little wrong on direction.
You can test this out using our real time stock alerts. Practice selling put options and see how it works.
Is Selling Puts Safe?
- Is selling puts safe? Selling a put means that you’re bullish on the stock. Buying a call is the inverse strategy. Being an options seller puts the trading odds more in your favor. Selling naked puts is still a risky strategy and is safest when turning it into a credit spread.
You Look Forward to Market Downturns
I love short selling and to be quite honest, I look forward to the days when the market drops 1-2%. Watching stocks tank due to panic selling, “fear”, should have you clicking your heels like Dorothy from the Wizard of Oz.
Honestly, this is the best time to sell put options since volatility (a.k.a panic) is at its highest. Don’t forget that selling puts is actually a bullish strategy. Therefore, you want to sell puts knowing the stock is going up.
This is how you capitalize on fear. Firstly, scroll through your watch list to find stocks that are oversold (i.e. selling off). Secondly, sell puts with a strike price near a support level.
As emotions calm down over the next few days, volatility follows, and thus the market will once again gain equilibrium. As a result, you will be left with a small gain in your position. Nice!
Check out our live trading room to see us in action.
You Can Make Use of Your Margin
Now I’m not going to encourage you to use margin if you’re not a seasoned trader. There’s nothing like a margin call from your broker to induce a mild heart attack.
If you want to get in the game of selling put options, you will be required to put up some cash as margin. And how much depends on the underlying price of the security and option.
Typically it’s capped at the strike price * 100 per contract (because each contract has 100 shares). So, if you sold one $20 put option, the cash you have to front is $2,000 ($20 * 100).
A Little Tip on How to Sell Put Options
If you didn’t know, in some instances around 30% of your equity value is added to your initial and maintenance margin. This means you can only use 70% of the market value to counterbalance the margin requirements of your put options.
Just in case the market quickly turns against you, it would be wise to have 30% of your margin amount in cash. This will prevent the dreaded margin call from your broker.
A Word of Caution on How to Sell Put Options
Selling naked or uncovered puts is not a low-risk strategy for the faint of heart. This is because you’re selling put options without actually holding a short position in the underlying security.
Realistically, however, if you’re a seller of options you will likely repurchase them well before the price of the underlying security falls too far below the strike price.
This can easily be accomplished by checking prices daily, setting stop-losses and setting alerts so you’re notified when this happens.
The Bottom Line
Because of the high risk involved, only experienced options investors should sell puts that are naked. Luckily though there are lots of different covered put options you can utilize to protect yourself from the changing tides of the market.
If you need more help, take our options trading course.