Put writing is an essential part of options strategies. Selling a put is a strategy where an investor writes a put contract, and by selling the contract to the put buyer, the investor has sold the right to sell shares at a specific price. Thus, the put buyer now has the right to sell shares to the put seller. If the stock's price falls below the strike price, the put seller will have to purchase shares from the put buyer when the option is exercised. Learn how to breakdown options into easy-to-understand and relatable concepts and see real-time how options trading actually works in Invetopedia Academy's Options for Beginners course ].
Put writing can be a very profitable method, not only for generating income but also for entering a stock at a predetermined price. Put writing generates income because the writer of any option contract receives the premium while the buyer obtains the option rights. If timed correctly, a put-writing strategy can generate profits for the seller as long as he or she is not forced to buy shares of the underlying stock. Thus, one of the major risks the put-seller faces is the possibility of the stock price falling below the strike price, forcing the put-seller to buy shares at the strike price.
Also note that the amount of money or margin required in such an event will be much larger than the option premium itself. These concepts will become clearer once we consider an example. Instead of using the premium-collection strategy, a put writer might want to purchase shares at a predetermined price that is lower than the current market price. In this case, the put writer would sell a put at a strike price below the current market price and collect the premium.
Such a trader would be eager to purchase shares at the strike price, and as an added advantage he or she makes a profit on the option premium if the price remains high. Note, however, that the downside to this strategy is that the trader is buying a stock that is falling or has fallen.
Each put contract is for shares. To close out the outstanding put prior to expiry, the put-seller would purchase back the put contract in the open market. If the stock's price has remained constant or risen, the put seller will generally earn a profit on his or her position.
If, however, the price of XYZ has fallen dramatically, the put-seller will either be forced to buy the put option at a much higher price or forced to purchase the shares at above-market prices. Selling puts can be a rewarding strategy in a stagnant or rising stock, since an investor is able to collect put premiums without incurring significant losses. In the case of a falling stock, however, a put seller is exposed to significant risk - even though the put seller's risk is limited.
In theory, any stock can fall to a value of 0. As in any option trade, always make sure that you are informed about what can go wrong. Due to the risks involved, put writing is rarely used alone. Investors typically use puts in combination with other options contracts. Dictionary Term Of The Day. Broker Reviews Find the best broker for your trading or investing needs See Reviews.
Sophisticated content for financial advisors around investment strategies, industry trends, and advisor education. A celebration of the most influential advisors and their contributions to critical conversations on finance. Become a day trader. Learn how to breakdown options into easy-to-understand and relatable concepts and see real-time how options trading actually works in Invetopedia Academy's Options for Beginners course ] Why Would You Consider This Strategy?
Case Closed To close out the outstanding put prior to expiry, the put-seller would purchase back the put contract in the open market. The Bottom Line Selling puts can be a rewarding strategy in a stagnant or rising stock, since an investor is able to collect put premiums without incurring significant losses.
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