Selling Put Options for Monthly Income

Jul 16, 2024

Selling Put Options for Monthly Income

Overview

  • High probability of success in rising, neutral, and slowly declining markets.
  • Covers everything about selling put options, including examples, risk reduction, and case studies.

Put Options Basics

  • Financial contracts giving the buyer the ability to sell 100 shares at a fixed price before a specified date.
  • Value increases as the stock price goes down; seen as an insurance contract against stock price decrease.
  • Tips:
    • Stock price down = Put value up.
    • If stock price remains above strike price, the put value trends to zero by expiration, and the put expires worthless.
    • Sellers profit if the option expires worthless.

Selling Put Options

  • A bullish strategy: profit as long as the stock price stays above the strike price.
  • Example: Amazon put option
    • Initial Amazon price: $85/share.
    • Investor sells an $80 strike put for $3.55, receiving $355.
    • Profits if the stock price remains above $80.
    • Can close the position early to secure profits.

Risk and Losses

  • Example of a losing trade: Shorting Apple 185 put.
    • Initial put sale price: $1.90.
    • Ending put price due to stock price drop: $13.79.
    • Result: ~$1,200 loss.
  • Risk and assignments:
    • Exercise and assignment: If exercised, the seller buys 100 shares at the strike price.
    • Max loss: Occurs if stock price goes to zero.

Option Expiration and Assignment

  • Automatic assignment if holding an in-the-money option through expiration.
  • In the money: stock price is below the strike price by 1 penny or more.
  • To avoid assignment, buy back the option early.

Margin Requirements

  • Example: Amazon 125 strike put with high margin requirement of $1,669.
  • Potentially high returns on capital (up to 12% in 44 days).

Case Study: Amazon from Jan - Nov 2023

  • Monthly short put strategy.
  • Put strike 5% below stock price each month.
  • Resulted in consistent profits except for a significant loss in September.

Risk Reduction Techniques

  1. Sell Put Spreads (Put Credit Spreads)
    • Combine short put with long put at a lower strike price.
    • Limits downside loss.
    • Example: Short 240 put with 230 long put creates limited-risk spread with lower margin requirements.
  2. Caution after Market Increases
    • Avoid selling puts at resistance levels where potential for stock price decline is high.
  3. Sell Puts During High Implied Volatility
    • More expensive options means higher premiums and ability to choose safer strike prices.
    • Historical example: Higher implied volatility in 2023 led to higher put prices.
    • Benefits: Protective against downside and typically coincides with market bottoms.
    • Decreasing implied volatility after a stock price rally crushes put option prices.
  • VIX Index: Measure of market-wide implied volatility. Higher VIX = higher option prices.

Practical Tips

  • Monitor implied volatility and sell puts when it is high.
  • Avoid selling puts during periods of significant stock market decline.
  • Use put spreads to limit risk.

Conclusion

  • Selling put options can provide steady monthly income.
  • Importance of risk management and strategic timing.
  • Detailed strategies and case studies demonstrate potential and pitfalls.
  • PDFs and additional resources are available for comprehensive learning.

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