Selling put options can be an aggressive strategy used to collect premiums or buy shares at a discount, but it comes with unlimited risk for the seller. However, a large percentage of options expire worthless, making it potentially profitable. Technical analysis is crucial, and the trader must be willing to buy the shares. The biggest risk is ownership of the shares, which could result in a total loss.
Selling or writing put options is usually done by highly skilled and professional traders. Strategies used to sell put options in the stock market are considered aggressive. They can be used to collect premiums or to purchase shares at a discount to current market value.
Put options are financial contracts that give the buyer the right to sell a particular stock at the selected strike price on or before expiration. The seller of the put option is obligated to purchase a particular share at the selected strike price on or before expiration. The buyer has rights, and the maximum loss is the premium paid for the option. The seller has obligations and the maximum loss is practically unlimited.
At first glance, this may seem like a bad deal for selling put options, since only a small premium can be charged for taking unlimited risk. The write trade may be acceptable upon closer inspection of the actual risk and reward possibilities. Recent studies indicate that a very large percentage of options expire worthless. This is bad news for option buyers and great news for option sellers.
If the purchased option has expired worthless, the premium will be forfeited to the seller. This would suggest that option sellers are more profitable than option buyers. Before implementing these unlimited risk trades, the investor must be informed and educated. Online resources are available to explain the risks and rewards of standardized options. Entering this market without a thorough understanding of putting put options could be a very risky undertaking.
A successful trade is a function of the investment objective. The objective of selling put options may be to collect the premium paid by the buyer. Another objective may be to buy the shares at a discount to the current market value. The informed trader can select both targets, resulting in a winning trade each time. The result of selling a correctly placed put option trade will be to charge a premium or buy the stock at a discount to the current market value. This is the best strategy for selling put options as it can be considered a winning trade regardless of the outcome.
This type of trading is very easy to implement, but the trader must be able to evaluate the stock based on fundamental and technical analysis. The appropriate time to enter this trade is when the stock and the market in general are at or near an area of greatest support as determined by technical analysis. Entering this trade without the use of technical analysis is nothing more than a game of chance.
The main requirement of this strategy is the willingness and ability to buy the shares that are traded. If the investor is not interested in owning shares, then this is not a good strategy. By selling a put option, the trader can make a profit by taking ownership of a stock that he is already interested in buying at a discount to the current market value. If this scenario doesn’t work, the seller will earn the premium paid by the buyer.
The biggest risk taken when using this strategy is ownership of the shares. The company could declare bankruptcy resulting in a total loss for the merchant. The value of the shares can decrease by forcing the trader to hold the shares for a long period or sell the shares at a loss. Both scenarios could also happen if the trader bought the stock outright without capturing the discount available by writing put options.
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