Selling (or “writing”) puts is a strategy that uses options to take a bullish position.
When we sell a put, we are agreeing to buy 100 shares of a particular (underlying) stock at a set price (strike price) through a set expiration date, if the owner (buyer) of the option asks us to.
“Premium” is the term that describes the per share price that we received upon the sale of the put. Because each put contract represents 100 shares of stock, the actual dollars received would be 100 times the premium per share.
Once we’ve sold a put, our best case scenario occurs if the underlying stock closes at or above the strike price on the option’s expiration date. In this case, the obligation to buy gets extinguished, and the premium we collected is 100% profit.
If the underlying stock closes below the strike price at expiration, the put would be exercised. If we did nothing, we would own 100 shares per contract at a net cost of the strike price minus the per share premium initially received. That amount is the “break-even” price.
Why sell a put?
- Sale of put premium generates immediate income
- ‘If Put’ prices are lower than market prices at the trade’s inception because the premium for selling the put is retained by the seller – i.e., there’s a discount on the shares.
- Due to the discount, put writers have a built-in ‘margin of safety’ that an outright stock purchase doesn’t provide.