Selling Put Otions

Selling Put Options We recently learned that options are a nice way to capitalize on the price movement of an underlying asset while limiting risk. They can, however, offer a source of income when sold. For example, on can sell a put option and collect the premium. As long as the stock price remains above the strike price, the option holder makes money.

 

Suppose company ABC has a put option with a premium of $5. The option expires in December and has a strike price of $20. The stock currently trades at $22. If you sold the put option today, you would pocket $5. If the stock remains above $20 at expiration, you keep the full $5. If the stock is below $20 at expiration, your position will be worth less. Suppose at expiration, the stock is trading at $10. The option you sold will be exercised meaning the holder will sell the stock to you for $20. You will now own the stock at a purchase price of $20 even though it is only worth $10 in the market. On paper, you have already lost $10 on this position although you keep $5 from the premium you received when you sold it. In all, you've lost $5.

 

Selling put options can be an effective way to generate income for your portfolio. You essentially maintain a bullish outlook on the stock since you benefit when the stock price is above the strike price. It is sometimes better than buying the stock outright since it involves less capital up front. However, at expiration, you may be on the hook for a sizable purchase if the stock price falls below the strike price.

Reuben Advani is the president of The BARBRI Financial Skills Institute and the author of two finance books. More information on this and other topics can be found at http://legalpractice.barbri.com.

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