These questions might sound trivial, and perhaps they are, but I am new to the forum. Basically, if I choose to sell put options, I will be paid money if the stock price on the expiration date is higher than the strike price? (all while not buying the stock) Conversely, I will be required to buy the stock (100 shares, assuming one contract) if the stock price falls below the strike price? (I will still be paid money from the contract) If the strike price is set at like 85...and the stock at the time the contract expires falls to 75 or something, I am required to purchase 100 shares at 85, correct? This sounds like something that would be a strong strategy if you were interested in buying an individual stock and holding it for a bit?
Hi Craig...yes..you have the gist of it. Most options are American exercise which means they can be exercised before option expiration day as opposed to European exercise which can only be exercised on op ex. It "can" be a good strat for buying a stock....many people do it. However if the stock is very volatile it can move away from you and get more expensive to buy. example... you really want to own xyz at 20...(current price 21) so you sell a 20 put for Aug and receive .50cents. Earnings come out and are great and stock goes to 23. You get to pocket the 50 cents but had you actually bought the stock you would be up $2. The downside risk is it goes to 19 and gets put to you and drops even farther...yuck. No free lunch here. Most people will buy back the put and take the profit/loss without fooling with the stock.
<<< Basically, if I choose to sell put options, I will be paid money if the stock price on the expiration date is higher than the strike price? (all while not buying the stock >>> You will be paid the credit into your account, as soon as you sell the put, regardless of what the stock does. To put that into perspective, if you need $2,000 to initate a cash secured put, but only have $1,800 in your account, you can still initiate the trade if the credit you will receive is $200.... (plus commission costs). In terms of investors buying back the put early, to lock in the profit, release funds, and close the trade,... if it's a 4 - 5 week contract, and the stock really shoots up the 1st week or two, it's reasonable to close it down if there is only a small amount of credit to return, so you keep around 75% or more However, if there is less than a week to go, and your stock is safely OTM, now you have to think about whether it's worth closing it down a few days early and paying an extra commission. For me, if I see another stock i like, that is trading where I want it, and is paying the credit I desire, and don't want to risk missing the deal, and I need to raise cash, I'll close a put down down expiring soon. But if i don't see something else to get into, I'm probably not going to give back any credit on a trade OTM, just to sit in cash and earn nothing. However, if earnings are coming out soon, or I'm over concentrated in a stock, or over leveraged, or the stock is a volatile piece of crap, and so on.... So as you can see, there are lots of issues to consider when evaluating whether to buy back a put early and close the trade.
<<< This sounds like something that would be a strong strategy if you were interested in buying an individual stock and holding it for a bit? >>> It's a good strategy if you want to be "paid to wait" for a stock to drop to your desired price. But you only get to buy it at that desired price, if it drops below it. But it sure does beat NOT getting paid to wait.... if you plan to wait for a particular price. Most investors who sell puts do it to collect the premium and not the stock. But it's a good strategy either way. Is your primary goal to collect the option credit, or to collect stocks? Personally, I'm in it for the credit. But if the occasional stock gets put to me, I'm happy to own it for a while , and then sell a covered call on it for an additional premium. Sometimes at the original strike, and sometimes I'll select a strike below it. Depends on what i think the stock and the market may do over the next month.
First, thanks all for the responses. They were all helpful. To answer your specific question, I feel that if I engaged in this strategy, I would only be doing it to collect the premiums. However I wouldnt go crazy and start selling puts for the sake of premiums. I feel that this strategy only works optimally if its with a security you ALREADY planned on going long. So basically, I think I would be in the same boat as you....option credit. I have another question. Lets say the premium is 100 dollars for the contract, and say the strike date is...4 weeks away...The buyer decides to exercise his option after one week...do I receive the full premium or is it prorated? (So, in this example, would I get the full 100, or 25?) thanks!
Easy one so I will take it! No pro-rata basis. The day the put deal was done 100 bucks was debited from the buyer's account and into your account. No going back on this. Whatever eventually happens, exercise or expiry of the put worthless is irrelevant.
This is all correct. However consider this. If a stock is trading at $100 and I sell the naked 85 put saying I like the $100 stock and would love to buy it at $85, I 'll make the case that at 15% lower, you might not. If the stock were to fall 15%, the market conditions might have changed. The outlook for the sock might have changed. You might find that at $85, you'd rather be a seller. I'm a natural option seller. I would never use that as a reason to sell the put. I would want to be paid for my risk and have some conviction that the put will remain OTM. 1245
Hi there, you make a good point...is this also in the same ball park as "well hell, what if the stock goes way BELOW 85 and below the amount where your risk premium covers it...then you might be buying a 60-70 dollar stock for 85 dollars." i don't know why i used quotation marks....don't think those were appropriate. anyways... I think I understand the risk in this a bit better now. However those premiums are awfully alluring! Options simply seem like an insurance company in the equity market.
Yes they are. However insurance policies are priced with higher margins. Just like insurance, pricing the instrument will determine if yur profitable over time.