If you’re trying to up your investing game, consider buying and selling options. Selling puts is the most common place to start because it’s simple and often profitable. Investors who sell puts often see consistent returns for their efforts.
Let’s look at how the process works.
What are Put Options?
A put option gives the seller (you) the obligation to buy shares at the strike price (named price) before the option’s expiration date if the price drops that low. In other words, you promise to buy X number of shares if it hits a specific price.
While it’s called an ‘option’ when you sell puts, you have the obligation to buy the stock at the specified price. When you buy an option, such as a put, you have the right, but not the obligation.
Selling puts is honestly the best of both worlds. You make money selling the contract whether or not you execute it. If you execute the contract, you now own stock that you wanted to own anyway. If the price never falls below the specified price (strike price), you make a small profit on the options contract. But be careful if you exercise the contract, some brokers charge an exercise fee.
An Example of Selling Puts
You’ve had your eye on XYZ stock. It’s currently selling at $20 a share and you can sell a put with a strike price of $17 a share for $0.50. Each contract is worth 100 shares, so you sell the contract for $50.
The contract has an expiration date of 45 days.
Here are two ways this can go.
The stock price drops to $16 a share. You are obligated to buy the shares at $17 a share. But, since you made $50 on the sale of the contract, your cost basis is lower – $16.50 a share. You already come out ahead on the deal.
Now you own 100 shares of XYZ stock and can do with it what you want. This means you can sell the stocks at any point – you don’t have to hold onto them. With a lower cost basis, you may sell them sooner and still make a profit.
Now, if the stock price didn’t drop, let’s say it fell to $18. You would not be obligated to buy the shares. The put contract would expire and you’d walk away with a $60 profit.
The Benefits of Selling Puts
It may seem like selling puts makes minimal returns, but it is a profitable way to make the most of options trading. Here’s why.
You enter the market at the stock position you want. You are in charge of the price you buy (the strike price on the contract you sell). You can keep your cost basis as low as possible and buy stocks at lower prices (when they fall) for greater profitability.
Selling puts gives you a little cushion on your profits. You sell the put at a strike price. Typically there’s room in that strike price for the stock to fall, but not so low that you have to buy the stock. You walk away with a small profit and without the need to invest in the stock – you make money having a bearish outlook.
Selling puts also helps you make an income while you wait for a stock price to fall as low as you want. For example, if you have your eye on a stock but you want it to fall to $15 a share (it’s currently at $20). You can keep selling put contracts until the price drops to the strike price you want.
While you wait, you collect the premium from the put contracts. While it’s not the same returns you’d likely make owning the stock itself, it’s better than sitting on nothing while you wait for the stock to drop low enough.
Selling Puts can be Profitable
Like any investment, selling puts is risky but can be profitable. There isn’t a foolproof investment anyone can make with 100% certainty, but it’s a great strategy even for beginning investors.
Selling put contracts, though, is a great way to make some money while figuring out what else you want to do with your portfolio. You won’t get rich selling put contracts, but you might make some premium that you can invest in other stocks or investments, making your investments grow faster than you thought possible.