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Selling puts

  1. Hi,

    I am wondering if you are short the stock and if you sell puts out of the money, what exactly happens in the scenario ? I am short 600 shares of GS stock and if I sell 6 contracts for a 65 strike price for January expiration, do I simply collect the premium and effectively close the trade if it ever gets to 65 ?

    Thanks very much.
  2. 1) You could if you wanted to. However, you would be giving up the remaining extrinsic premium in the put options.
    2) On a price drop from ~$77/share to $65/share, implied volatility levels would probably increase which would tend to firm-up the option, to your detriment.
    3) I'll assume that you already know that a covered-put is the same as a short-call.
  3. Thanks for the reply.

    I was actually thinking of placing this trade as a hedge against my short trade. Is it advisable to sell puts against the short position for a hedge ?

    So, if the stock doesn't go down much, I can keep the premium. If it does go down, I benefit in my short position and still keep the premium. If I understand this correctly, I am limiting my profit potential to 65 in a short trade by this strategy.

    Please let me know if there is something I am missing.

    Thanks a lot.
  4. You are not missing anything. Is it advisable? It's a personal decision.

    Sometimes a stockholder writes a covered call to gain some premium. In return, the big upside is sacrificed.

    The short seller can do the same thing by writing put options. You collect premium, but if the stock really tanks, you sacrifice some profit potential.

    Yes, if the stock is below the strike at expiration, you will be assigned an exercise notice - thereby covering your short stock position (at $65/share).

  5. Thanks.

    So if the stock were to go significantly below 65, it should not affect me in any way, right ? (since I am essentially closing out my trade at 65).

    If I want to get out of my short trade before the expiration, I have to either buy back the puts or be ready to get assigned the stock if it gets to the strike price, right ?

    Thanks again.
  6. Think of the covered put (CP) as the mirror image of the covered call (CC).

    With an OTM CC, if the stock rises, you capture appreciation from the stock's price to the strike price plus you keep the premium received. Your loss would begin below the stock's pruchase price less the call premium received.

    In the case of your GS OTM 65 CP, you would capture appreciation from the stock's price down to the strike price (65) plus you'd keep the premium received. Your loss would begin above the stock's sale price plus the put premium received. If the stock finished ITM and you were assigned on the short puts, you'd be buying the 600 shares and that would close your short position.

    As noted by NAZZdack, an increase in IV on a drop to 65 would be mildly detrimental if you were looking to close the position prior to expiration - it would slightly diminish your net profit. Near expiration, it would be almost irrelevant. It's really not a concern. What you should be careful about is that it's still a short position and you need to watch the upside whether you sell the puts or not. Good luck.

  7. Consider strike prices closer to at-the-money so that you collect decent premiums and benefit from early exercise instead of hoping for "large" capital gains.
  8. Mark
  9. I don't believe this is reasonable advice to give someone.

    It's a personal decision whether to write ATM, CTM, OTM, or FOTM options. Just because it suits you to write options with a larger premium (it also suits me), that does not mean it's a good idea for someone else.

  10. 1) Options with smaller premiums don't hedge a position. They behave more like separate outright positions.
    2) Since larger premiums do suit you, then what I dispensed was, indeed, good and reasonable advice. Your preference to be "objective" instead of demonstrative is your problem.
  11. It is very critical to know that if the stock were to go below the strike price "before the expiration day", it may not mean anything. In other words, everything typically hinges on the price of the stock the day of expiration.

    It makes sense that the option buyer would want to take advantage of his right to hold off on the decision until the expiration. Since I have not done this kind of a trade, I am not sure what happens.

    Worst case scenario : If you are short the stock and if it starts going up, you take a loss and decide to exit. Then it starts falling again and go below your strike price and you are either stuck with buying the puts at a lower price or get exercised the stock. Is this correct ?

    Thanks a lot for your help.