When considering an options trade, it makes sense to consider “buying to open” an option position and “selling to open” an option position. Before we go into details about when and how we would buy or sell an option to open a new position – let’s first discuss the difference between option buyers and sellers.
Option sellers have obligations, while option buyers have rights. An option buyer has the right to “put the stock” on someone (put buyers) or to “call away someone’s stock” (call buyers). An options seller must take that stock (put sellers) or give up that stock (call sellers).
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What Does It Mean to Sell a Put?
When would a trader consider “selling to open” a put position? If that trader wants to collect the stock eventually. Or when a trader wants to be a “premium seller” and profit from a stock above the strike sold.
Traders who believe the stock price will rise higher than the strike sold. Or traders who believe the stock will stay higher than the strike sold. They may consider selling puts (to open the trade) as an alternative to buying calls. Why…? Because this trade does not require a movement in the stock price to increase profits.
Buying vs Selling
Let me explain; if I buy a call, I need to see the price move, and I will profit from that movement. The farther the price and the faster it moves, the more money I could make (in theory). But with a short put (or – with a put sold to open), I don’t need price to do anything more than get above (or stay above) the put I sold to open. These two trades require two different things from the market.
Some traders would agree that picking the direction of a stock is difficult enough and that “adding time in trade” with “distance moved” makes trading even more difficult. But with selling to open a put option – the trader only needs to determine where a stock should not go and then sell a put below that level.
Some people consider put selling to be a bullish strategy (because it can be used to purchase shares, which is bullish eventually). Still, it can also be considered a “bullish neutral” strategy because if we sell puts below the current stock price, then the price just has to stay above our put. Theta decay will slowly pay us the premium as the option value fades.
Put Spreads
When it comes to selling a put for a bullish neutral bias – the trader needs the margin to cover 100 shares of stock, and this can be costly; if you want to sell a put and cannot pay for 100 shares, then you could consider selling a put spread instead. By selling a put (to open) and buying a put (to open), the long put would cover you if your short put is exercised. The CBOE suggests that only 10% of options are ever exercised.
Premium Selling
Many traders use put selling as a premium selling strategy – because it does not need traders to focus too much on “catching the open” it’s generally a swing trade that requires only a little attention from the trader on a day-to-day basis. Options are famous for slowly losing value, so an options seller works with time on their side.
How to Sell a Put Option
First – find a stock that you can afford and that you believe will not fall below a key level. Second – look at the various expirations to find a “time in trade” that you are comfortable with. You could ask a question like “Do you think this stock will stay above 100.00 for six weeks?” If the answer is yes, then you have a timeframe to focus on in the options chain).
Third – consider what you will do if the stock price falls below your strike. Have a plan – such as buying the put to close the trade. Or, rolling the put out in time and lower on the options chain). Fourth, after you have an exit plan ready, try to hit the mid-price on the option or even try to sell the options at a slightly higher price than the mid-price. Work the order until it fills.
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Some things to Avoid
Some things can make options trading difficult, and if you avoid these things, you are likely to avoid complications and losses; we want to avoid dividend dates, earnings, scheduled events (like investor days events or new product launches), and stock splits, too. High volatility stocks are another thing to avoid – although this is a two-sided argument.
We want to sell options with a higher premium (inflated due to increased volatility). At the same time, we want to avoid trading stocks acting violently or showing a lot of volatility. Try not to seek out the highest volatility markets – while also not seeing out the lowest volatility markets. A stock with an implied volatility above 40 is considered ok, while a stock with an implied volatility greater than 80 would be considered dangerous.
Assignment Risk / Exercise Risk
As option sellers – we are obligated to take the stock if someone “puts the stock on us” or if someone exercises their rights as a put buyer. Options expiration is not common, but it does happen and is more common if the put goes too deep in the money or the options are ITM at expiration. ITM options will always automatically cause assignment at expiration – so if you do not want to own the stock, you must close the option before it expires.
Calculate Your Losses
The short put position can lose like any other trade, so let’s evaluate how a loss is calculated in a short put position. We would subtract the put strike from the closing price at expiration. Suppose I STO a put at the 100 strike, and the stock closes at $90.00 at expiration. I would hold a put ITM at expiration and be assigned 100 shares at $100.00 each ($10,000).
The current stock price of $90.00 each ($9,000) means I am losing $10.00 per share (or $1,000). To determine the potential loss on a trade before entering it- consider the stock price for your exit. How much pain are you going to take before you decide to close the trade?
What to Consider Before Selling a Put
You’re taking the bullish bias when you sell puts. As a result, you need to know when a stock will reverse from the downside. How can you find that out? By looking at candlesticks and patterns along with support and
resistance. If you want to sell, look to sell when it can’t break support.
Once it returns to resistance, you’re in the green while someone else is in the red. That might sound harsh. However, that’s the nature of stock trading. The stock market is a battle of buyers and sellers. It’s what moves the market. Without that battle, there’s be no price action. Without price action, no one would make any money.
Candlesticks are the foundation of trading. Without candlesticks, technical analysis means nothing. By themselves, candlesticks tell a story. However, group them, and you’ve got patterns. Patterns and technical analysis will give you a clearer picture of the type of trade you should be making.
Delta – Traders can use Delta as a “probability of expiring ITM” to help them consistently build positions. It allows them to capitalize on a “better than 50% chance of profit.” This gives them an edge over the “buy side” traders. To do this – look at the Delta on the options chain and choose a strike with a Delta lower than 50%.
Remember that even the best “buy side” traders fail 30-40% of the time. You may not hit it out of the park every time, but you’ll do well if you trade the setups.
Practice in a Simulated Account
Before selling to open, put positions – consider trading in paper to get familiar with the decay style of options. Also, see how the prices will change when the price places that option ITM.
Work the order to fill the trade at mid or better (to open a short trade). Then, fill again at mid or less (to close a short trade). This is because, as sellers, we want to use STO for as much money as possible and buy to close (BTC) for the least amount.
Final Thoughts: Sell a Put
Put selling is a great way to earn a consistent profit from premium selling. It is the starting point for several trading strategies, such as the “Wheel” options trade. This is a way for stock traders to increase their stock holdings (by taking assignment of the stock at expiration when the puts are ITM). This is useful for traders who want to “dollar cost overage” their stock purchases. Also, if they are not in too much of a hurry to build their position.
Put selling is popular because it is often easier to determine where a stock should not go. This is compared to determining where a stock price will go and how fast it will get there. The assignment risk is low if the option is near the money or OTM, and a lot of time is left before it expires.
Frequently Asked Questions
The biggest risk of selling put options is that traders are obligated to purchase the stock and the exercised strike price, even if the stock price falls to zero.
Selling a put is a bullish options trade. It's a naked selling strategy where a trader wants to profit on the underlying stock going up.
Writing a put option means that the person sold the put option to the buyer and has to purchase the stock at the strike price if exercised.
