Stephen Cooper

Selling Puts

RupertB said: "Lets say I've identified a good stock: A business I like, good financials, and selling at an advantageous price. I decide that I'd like to own this stock as long as I can get in at or below $50 but it has been trading in a range between $52 & $57. I have the money to buy but instead I sell puts on the stock, pocketing a premium for the obligation to buy at $50. I know I want the stock. I can get paid for the obligation to buy, though I'd buy tomorrow if it fell to my price target. If I can get more money for more time value, why shouldn't I sell puts as far out in time as possible? Once the stock is "put" to me (if it ever is) the contract has been fulfilled. If I sell a year's worth of time value (out of the money put) and the contract is exercised the next day, all I've done is reduced my cost basis. I know there is a down-side (market crashes & stays down) but this seems almost too good to be true. What am I missing here?"

drdan said: "Pretty much that is it. The downside is crashes. It was the most common way for brokerage companies to buy their stocks in the 90s on a pullback, but in the mean time they were collecting premiums that were even better than they are today. Then a lot of them went belly up on the margin calls when the markets tanked, too many naked puts out there and the markets were dropping fast. A lot of money was lost on naked puts. For the experienced trader that likes bargins and has the capital to buy the stock if it is put to them, then naked puts are the way to go. It is very difficult to lose unless the stock you are buying tanks. The problem with your idea of selling a year out. It is much more profitable to sell a month or two months out. Take a look at the option charts and you will see what I mean as you go further out the time value does increase but at a lower rate. Also most people like to get their premium and be out of the trade in under 60 days and not have to wait a year with their money tied up, because the worst thing that could happen is that the stock does fall below your strike price and you are NOT put the stock, when the rebound occurs you are still stuck in the sold put unless you buy it back."

Quin said: "In addition to what DrDan pointed out, there is also potentially the lost opportunity costs. You've identified a stock you like and you believe it could go higher. What if it doesn't trade down to your put strike price? But instead, it goes straight up? As a put writer, you do not participate in any of that upward gain. It is a lost opportunity to the writer."

Rickster said: "I would agree that if you are going to do this, you should sell the near puts. It is extremely unlikely that the stock will be put to you before expiration. So, as said above, if you sell the long term puts, you will have your money tied up on slowly decaying options. If you sell the near puts, the premium decays faster and you get a chance each month to adjust the strike price up or down. As for me, I make a shopping list, wait for a broad based panic and then load up. I dont bother with selling puts."

Darren said: "What's a mathematic way to represent "opportunity costs"?"