💰 Earning Premium and Setting Your Price: The Power of Selling Put Options
Selling (or "writing") put options is a popular strategy used by investors who seek to earn premium income while simultaneously being willing to buy a stock at a lower, predetermined price. This approach can be a powerful tool for conservative, value-oriented investors.
What is a Put Option?
A put option contract gives the buyer the right, but not the obligation, to sell 100 shares of the underlying stock to the seller (writer) of the option at a specific price (strike price) on or before a specific date (expiration date). As the seller of the put option, you take on the obligation to buy those 100 shares if the buyer chooses to exercise their right.
The Mechanism of Earning Premium
When you sell a put option, you immediately receive a payment from the buyer. This payment is called the premium.
Your Goal: Your primary goal in this transaction is to have the option expire worthless (unexercised).
How it Works: If the stock price stays above the strike price until expiration, the option buyer has no incentive to sell their shares to you at a lower price. The option expires, you keep the entire premium, and you are under no further obligation. This is how you earn income.
The Opportunity to Buy at a Discount
The second key component of this strategy is the potential opportunity to acquire a stock you want at a favorable price.
1. Selecting the Right Stock and Strike Price
This strategy works best when applied to a stock you genuinely want to own for the long term.
Desired Entry Point: You select a strike price that represents the maximum price you are willing to pay for the stock. This is often a price below the stock's current market value—your target purchase price.
The Commitment: By selling the put option, you are essentially committing to buying 100 shares per contract at the chosen strike price if the stock drops significantly.
The Assignment Scenario
If the stock price falls below the strike price, the option is considered in-the-money, and the buyer will likely exercise their option (assign the stock to you).
The Result (Assignment): You are obligated to purchase 100 shares of the stock at the strike price.
Your True Cost Basis: Your effective purchase price is actually lower than the strike price because you get to keep the premium you initially received.
For example, if you sell a put with a $50 strike price for a $2.00 premium per share:
If assigned, you buy the stock for $50.
Your effective cost is $50 - $2.00 = $48.00
The Primary Risk: The maximum loss occurs if the stock price drops to zero. While rare, your theoretical loss is the strike price minus the premium you received. Therefore, never sell a put option on a stock you are not comfortable owning.
Selling put options is an excellent strategy for investors looking to generate cash flow from premium income while setting a favorable price for acquiring desirable stocks.
I would like to thank Tiger broker for sending me the option trading book and it opens my eyes on how to use options as part of my trading strategies
Disclaimer: Investing carries risk. This is not financial advice. The above content should not be regarded as an offer, recommendation, or solicitation on acquiring or disposing of any financial products, any associated discussions, comments, or posts by author or other users should not be considered as such either. It is solely for general information purpose only, which does not consider your own investment objectives, financial situations or needs. TTM assumes no responsibility or warranty for the accuracy and completeness of the information, investors should do their own research and may seek professional advice before investing.
