Sold Put Option

Posted on February 22nd, 2010 admin No Comments

Writing a put represents a short put option, which is a slightly bullish or neutral position. This strategy entails writing (selling) the put option with an obligation to buy a fixed number or amount of the underlying asset from the holder at a fixed price on or before a specific period of time. The trader or investor who executes this strategy is called the writer. The risk inherent of naked put writing can be extremely high and always carries margin requirements.

The reward in this strategy is limited to the option premium received for selling the put option. The risk is unlimited. Writing puts is used if you are bullish on the underlying asset, and is used basically to collect the premium when a trader or investor feels strongly that the put option contract will expire worthless, or will be worth less than the premium received.

Selling put options can be an alternative to buying shares. For example rather than buy 1000 BHP at the current share price $30.00, you can sell at-the-money puts expiring in a month and receive $1.50 ($1500). This means your break even price on the shares is $28.50. You have basically sold insurance so if the share increases you get to keep the $1500 and sell another put option. If the share decreases you have bought the share at $28.50 instead of $30.00 anyway. There are many more variables to take into account regarding this strategy which will be discussed later in the course under income strategy. Please contact me in the meantime if you wish to discuss trading this strategy.

Summary:

Market Outlook Neutral/Bullish
Risk Limited to strike price less premium
Potential Reward Premium Received
Premium Received at purchase, margin required
Time Decay (Theta) Positive
Volatility (Vega) Negative


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