Selling Puts

Selling puts can be a great strategy: It collects premium and offers the potential to buy stock at a discount. Selling a put takes advantage of several of the phenomena we discussed in Part Two, mainly the volatility risk premium, and since we’ll sell short-dated options, it will take maximum advantage of time decay.

As we discuss selling puts, it won’t be for speculation and it won’t be levered; rather it will be fully funded, meaning the put seller will have the cash set aside to pay for the stock if it’s put to him.

Almost every trader has entered a limit order to buy stock. It’s a great way to buy stock at a discount, at a price that’s more palatable then the current market price, which may have simply been too expensive. One of the problems with a limit order to buy stock is obviously the potential to never buy the stock and see it appreciate substantially.

The same problem exists for the option trader when selling puts with the added wrinkle that the stock has to be below our limit price (i.e., the put option strike price) at option expiration—so timing is an issue as well. If we’ve entered a limit order to buy shares then if the stock is below that limit price, for a month or a minute, we’re going to get our buy order filled. When selling puts to buy stock it’s not the amount of time the stock is below our strike price, it’s when that occurs. It has to occur at expiration.

While this is a deterrent to selling puts if a trader’s sole goal is to buy ...

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