Selling Puts to collect premiums

Corey said: "Lets say stock XYZ is at $40. I think it is a value play at $33. I see it potentially getting to that level in a couple months. Does it make sense for me to sell puts at $33 so that while I am waiting for the stock to fall, I can collect premiums? If it goes up, well, no real loss to me -- it just expires. And if it goes below $33, that is okay, because I wanted it at $33 anyway. Thoughts on this strategy? The downside here is obviously if the stock absolutely plummets -- but it seems like a good way to play a stock you want to buy at a lower price. The only time it doesn't seem like a good idea is if the cash could be better invested somewhere else. Good plan? Bad plan? Obviously, I am still a beginner when it comes to options..."

JCast3 said: "very good plan....make money on the way down, and then again on the way up....:th_dblthumb2:"

bklambco said: "Good plan, lots of people do this, Try to buy at high premium, and only the next month out so you can do it over and over until you get your stock or not. [QUOTE=Corey]Lets say stock XYZ is at $40. I think it is a value play at $33. I see it potentially getting to that level in a couple months. Does it make sense for me to sell puts at $33 so that while I am waiting for the stock to fall, I can collect premiums? If it goes up, well, no real loss to me -- it just expires. And if it goes below $33, that is okay, because I wanted it at $33 anyway. Thoughts on this strategy? The downside here is obviously if the stock absolutely plummets -- but it seems like a good way to play a stock you want to buy at a lower price. The only time it doesn't seem like a good idea is if the cash could be better invested somewhere else. Good plan? Bad plan? Obviously, I am still a beginner when it comes to options...[/QUOTE]"

Corey said: "Awesome. Now I just need to figure out more of the options jargon and how to write these things. I think I am starting to understand how these bad boys work. The theory seemed fairly safe to me. The only downside is if something unexpected happens...like accounting fraud or something like that. Then I might be screwed -- but hopefully the premium would help cover it."

holzie said: "Yes, that is a very successful strategy with options for stock traders. You want to own the stock, but not at this price ($40). If you put in a limit order to buy at $33, you will tie up a shitload of money for the 100 shares you wait to buy. If you sold a $35 put for $2.00 for example, then if the stock dropped to $35 or below in the expiration month, you would own 100 shares at 35-2=$33/share. In the meantime, while you are waiting for the stock, you are making modest return on your puts that you sell. Conversely, once you get it at $35, you might like selling the $40.00 calls against your 100 shares of XYZ. This way, if it holds for a while, you are making nice gains on the calls, and when it goes to $40, you collect (40+premium for call) - 33 = $ your profit. This is what options were originally designed for, anyways :) Holzie."

bklambco said: "I was going to add the covered call idea but guess Holzie beat me to it. I have a friend at work who is very heavy in stocks so I am helping him out do just this. Instead of talking to me first he went out and bought 500 shares of Ebay at 29 then asked me how to apply options to it. He had to have the bastard options that day so we went out and bought 5 contracts of covered calls at 32.50 for .45 he made $225 premium, next day premium shot up to 1.50 and stock up to 34, of course with premium at 1.50 no one exercised his stock at 34, so he still owns the stock and premium is at around .70 stock less than 32.40 now has an unrealized loss. If by feb 16th stock is below 32.50 he will keep his stock and premium, if above 32.50 and someone exercises it he will make the premium and profit from the stock. 32.50 - 29.00 and premium earned. So you can do it when buying the stock "sell a put" and after you buy it "sell a call" or covered calls there is no margin requirements since you already have the asset "stock" once you own it if you get called on it. To do a put you would sto "sell to open" a put at what ever at say strike of 33 at 1.50 after you own the 33 at 1.50 several weeks later if you change your mind on the stock and feel that the market might crash etc what ever, you can BTC "Buy to close" the 33 put at say .20 cents therefore you would make 1.50 - .20 or 1.30. To do a covered call you would sto "sell to open" a call at say strike 40 at 1.00 etc. Works the same as above you can buy it back for less the closer to expiration it gets or let it expire worthless as long as the stock price is below your strike price, and even sometimes you will not always be called to excercise the stock, not all options players want to own the stock when they buy calls and puts some just want to offset the options and earn the premium they gain. Example on ebay someone the day before bought from my friend at .45 next day it went to 1.50 they could have just sold the option they bought for .45 making 1.05 profit without excercising the stock or bothering to get the stock and all. So there are many people doing different things with options. Vast majority lose money straight puts and calls due to not understanding the effects of time decay on puts and calls during the last month of life they go to zero always."

rrvball said: "A few comments. First, I believe you meant sold instead of bought the 5 calls at 32.50 (see red below). Second, when the stock dropped to 32.40, your friend did not have an unrealized loss. He bought the stock at 29. And actually, as far as the IRS is concerned, his cost basis is 29 - .45 = 28.55 / share. So, he has an unrealized gain of 32.40 - 28.55 = 3.85 / share. Third, Holzie said [quote]you will tie up a shitload of money [/quote] What he means, in case you didn't know, is that selling a put requires margin, see your broker for your specific requirements. Also, selling puts requires a certain trading level. [quote=bklambco]I was going to add the covered call idea but guess Holzie beat me to it. I have a friend at work who is very heavy in stocks so I am helping him out do just this. Instead of talking to me first he went out and bought 500 shares of Ebay at 29 then asked me how to apply options to it. He had to have the bastard options that day so we went out and [COLOR=red]sold [/COLOR]5 contracts of covered calls at 32.50 for .45 he made $225 premium, next day premium shot up to 1.50 and stock up to 34, of course with premium at 1.50 no one exercised his stock at 34, so he still owns the stock and premium is at around .70 stock less than 32.40 now has an unrealized loss. If by feb 16th stock is below 32.50 he will keep his stock and premium, if above 32.50 and someone exercises it he will make the premium and profit from the stock. 32.50 - 29.00 and premium earned. So you can do it when buying the stock "sell a put" and after you buy it "sell a call" or covered calls there is no margin requirements since you already have the asset "stock" once you own it if you get called on it. To do a put you would sto "sell to open" a put at what ever at say strike of 33 at 1.50 after you own the 33 at 1.50 several weeks later if you change your mind on the stock and feel that the market might crash etc what ever, you can BTC "Buy to close" the 33 put at say .20 cents therefore you would make 1.50 - .20 or 1.30. To do a covered call you would sto "sell to open" a call at say strike 40 at 1.00 etc. Works the same as above you can buy it back for less the closer to expiration it gets or let it expire worthless as long as the stock price is below your strike price, and even sometimes you will not always be called to excercise the stock, not all options players want to own the stock when they buy calls and puts some just want to offset the options and earn the premium they gain. Example on ebay someone the day before bought from my friend at .45 next day it went to 1.50 they could have just sold the option they bought for .45 making 1.05 profit without excercising the stock or bothering to get the stock [COLOR=red]at[/COLOR] all. So there are many people doing different things with options. Vast majority lose money [COLOR=red]buying[/COLOR] straight puts and calls due to not understanding the effects of time decay on puts and calls. During the last month of life [COLOR=red]the time value always goes to zero[/COLOR].[/quote]"

bklambco said: "Thanks for the correction, right you always "sell" a put or call when collecting premium. You pick bid price on your platform. To buy it back you click the ask price. Put requires more margin since it is a naked position unless you want to do a credit spread that way you will use less margin, was watching tv and typing not paying attention to typos and stuff. [QUOTE=rrvball]A few comments. First, I believe you meant sold instead of bought the 5 calls at 32.50 (see red below). Second, when the stock dropped to 32.40, your friend did not have an unrealized loss. He bought the stock at 29. And actually, as far as the IRS is concerned, his cost basis is 29 - .45 = 28.55 / share. So, he has an unrealized gain of 32.40 - 28.55 = 3.85 / share. Third, Holzie said What he means, in case you didn't know, is that selling a put requires margin, see your broker for your specific requirements. Also, selling puts requires a certain trading level.[/QUOTE]"

holzie said: "[QUOTE]Third, Holzie said Quote: you will tie up a shitload of money What he means, in case you didn't know, is that selling a put requires margin, see your broker for your specific requirements. Also, selling puts requires a certain trading level. [/QUOTE] Well, my fault, I should have been more specific. See it all depends on the broker. In general, selling anything naked is a financial suicide, UNLESS you are actually after the potential buying or selling of the underlying. So in our EBAY case, and your friend's 500 shares. Let's presume he was wanting to buy them starting today. So, let's say he wants them at a price of $32.50 or better. Ebay is currently at $32.85. He could sell the 5 Mar 32.50 puts for 0.20 each. He could put in a limit order to buy at 32.30 (32.50 - 0.20) and tie up (non-margin account) $16,150 and wait, getting no money while waiting to get filled. Or, he sells the 5 puts and gets $100 credited into his account. The margin for doing that from my broker is $1,872, which is about 1/10th of the full limit order. Make no mistake, he wants the stock so he better have the $16,000 ready for the purchase anyways but he could have them working temporarily elsewhere. So, if by March 16th he doesn't get filled, if stock is above 32.50, he still made 100/1872 = 5.3% return on his money for waiting 36 days for the fill and he can do it all over again no matter where the stock is at that time. If he got filled, well, that's great too because that's what he ultimately wanted. So this is the only scenario in selling naked options where it is a WIN-WIN result. The margins differe from option to option of course, the margin on selling 5 Mar07 450 GOOG puts @ 6.80 each is $36,484...a return of 3400/36,484 = 9.3% in 36 days....again, if you want to own 500 shares of Google, and have the end buying power, it would be a POOR money management to tie up $235,920 in a limit order to buy GOOG at $450 per share. This is ultimately what distinguishes a trader from trader. If you tell me you made $100,000 last year "in the market", I am gonna ask you what total capital you were using. If you are using $1 mil to make a $100,00 and I am using $300 grand to make a 100K, I have a better yield, thus I am the better trader. Finance 101, or well, I think its Finance 340 or something like that, don't remember anymore :) This basic interpretation goes EXACTLY the same when you invest in companies. This is why in all my posts I rant about ROE, not how much the stock moved or could move. If I can own a company like Coca-Cola that makes me 30% in ROE a year, that means that my capital is being used efficiently despite the fact that the Street sees KO boring right now -- it is still being counted and it will reflect in its price eventually. On the other hand there are companies that are hyped right now with negative or low ROE -- not a very smart capital allocation going on in that company. Hope this helped in explaining my stand on selling naked options. Holzie."