Many people consider options trading a risky venture. You can, however earn a little extra income by selling puts. In fact, this strategy can be an income producing strategy and an acquisition strategy as well. You could actually earn income monthly while you are waiting for your targeted stock investment to reach the target price you have set.
First let’s just review a put option. As with a call option there are two ways to trade, you can buy puts or sell puts. When you buy a put, you as the buyer have the option to sell, or put, stock at a specified price for a specific period of time. Generally the investors buying puts have a negative outlook. They will profit if the stock goes down or will be able to sell, or put, their stock to another investor at a price higher than the current market price if it declines. The other investor who sold the put has the obligation to purchase the stock at a specified price for a specific period of time if the buyer exercises his or her option. Each option contract represents 100 shares of the given stock.
Here is a simple hypothetical example of how selling a put works:
Let’s say you are watching a stock that is currently at $22.00 a share. You like the stock as a long term and would purchase it if it pulls back to $20.00 per share. Instead of placing a limit order of $20 per share you could sell a put at the strike price of $20. When you do this you get paid a premium. In this case the premium for the $20 put price is $0.40. You have to sell at least one lot and one lot is 100 shares, so you get 100(number of shares in a lot) x 0.40 = $40.00 which is the premium you collect for selling.
When you sell the put you will be able to choose the time frame in which you are willing to purchase the stock. As a general rule if you are trying to make this an income strategy you’ll want to choose shorter time periods that are close to the current strike price.
When the option expires, if the stock has pulled back to $20 or lower by the expiration date your put will be exercised, meaning you will buy 100 shares of the stock for 20. For this to happen you need to make sure you have sufficient funds in you brokerage account, otherwise you’ll get a margin call meaning the broker will ask you for a deposit or sell other securities you own.
On the other hand, if the stock does not decline to 420 per share, you keep the $40 premium and the option expires. Now you can reevaluate the situation and sell next month you sell another one. You may want to look at a different stock or you may want to change the strike price you are willing to buy for. You might even want to set the strike price farther away from the current price to reduce the probability of having the put exercised.
Manage this process properly and you can earn a monthly income from the cash you have in your account.