Options: Selling PUTS
A semi passive income generating strategy – selling PUTS or short puts. Options have many options as well as many different names. Bull put spreads are also called credit put spreads. And so it goes on.
Let’s talk short puts!
They are bullish and provide you a credit meaning an income. What you receive is the max you get and your risk depends.
Selling a put is a simple, short term income strategy. A put is an option to sell. When you sell a put, you have sold someone the right to sell. As the stock falls, you may be obligated to buy the stock if you are exercised. Remember selling options earns you premium but also give you an obligation. When buying options it gives you the right to buy not an obligation and your maximum loss is your premium paid.
Selling PUTS is bullish. You are expecting the stock to rise or stay sideways at a minimum.
The purpose or rationale:
1. To pick up short term premium income as the share price expires worthless due to being higher than the strike price at expiration. (Expiring worthless)
2. To lower the cost basis of buying a stock if the put is exercised by being ITM at expiration (Price is less than the strike price)
This is a net credit transaction because you receive a premium for selling the put.
If your strike price expires ITM then you will be “put” the shares at cost basis of the put strike price less the premium you received.
Your maximum reward is limited to the premium you receive from the option.
Time decay works with your sold options. Therefore I prefer to sell premium in the shortest amount of time per premium. Lately it has been 2-8 weeks. Due to a lower VIX and lower IVs, premiums are slightly lower so I am going further out to gain more premium. More time on the options usually adds more premium.
As a general rule, I sell options less than 3 months and buy options 3 months plus. Of course it depends but those are the usual parameters.
Time decay works in your favor the last month and especially the last 1-2 weeks.
Don’t be fooled by the false economy that options with longer time to expiration are more lucrative. Compare a one month option to a 12 month option and multiply it by 12 and you will see that you are usually receiving far more per month especially with the liquidity available with the shorter term option. Compounding monthly or just have the option with fast liquidity makes the shorter time period a better return. Having options and liquidity are always key.
So the “sweet spot” is about a month away due to this time decay or theta.
Choosing stocks?
Higher IV stocks provide greater premiums but if the trade works against you then you should have precommitted stop losses in place or want to own the stock.
I usually utilize this strategy on companies I want to own or at least like at a price such as strike which is usually OTM. Liquidity and higher average daily volume is important.
Advantages:
1. Consistent income from rising or rangebound stocks.
2. Alternative way of buying stocks at a cheaper price than in the current market. Your cost will be the strike – premium received.
Example: you receive $2.5 per every put sold at a strike price of $50. If the stock closes at $49 on expiration, then the shares are “put” to you at $50-$2.5 so your cost is $47.50 while the stock trades at $49. So you effectively own it for LESS than market. However if it crashed to $45, you would still own it at $47.50 for an unrealized loss of $2.5 per share.
As you can see, the risk can be significant if the stock keeps dropping. What to do if it keeps dropping? You can buy back the sold PUT for a loss which is why I said to have pre-set stop losses in place. Or you can just buy the stock at the strike price and hold it. Or you can choose to “roll” the sold put further out to give you some extra time for it to “come back”. You can roll it out at a lower strike, same, or higher strike. Depends. I have done all of the above with success with all and disappointments with all. Meaning that any of the strategies can work well and it just depends on many factors.
I like this strategy a lot and use it extensively for both purposes. To own stocks I like lower and for consistent premiums.
If you are put the shares, there are many options to keep collecting premium on those shares. Sell covered calls on them. This is called the wheel strategy. You go back and forth on selling puts and then selling covered calls in a circle. Many options!
Happy options trading!