Selling a Put - You have an obligation to buy the security at a predetermined price to the option buyer.
Characteristics of Prudent Put Selling
Sell puts only if you’re comfortable owning the underlying security at the predetermined price because you’re assuming an obligation to buy if the counter-party chooses to sell. In addition, only enter trades where the net price paid for the underlying security is attractive. This is the most important consideration in selling puts profitably in any market environment. (There are other reasons to sell puts, especially when executing more complex options strategies. Learn more in Iron Condors Fly On Fragile Wings and Advanced Option Trading: The Modified Butterfly Spread.)
Other benefits of put selling can be exploited once this important pricing rule is satisfied. The ability to generate portfolio income sits at the top of this list because the seller keeps the entire premium if the sold put expires without exercise by the counter-party. Another key benefit: the opportunity to own the underlying security at a price below the current market price.
Put Selling In Practice
Let’s look at an example of prudent put selling. Shares in Company A are dazzling investors with increasing profits from its revolutionary products. The stock is currently trading at $270 and the price-to-earnings ratio is under 20, a reasonable valuation for this company’s fast growth track. If you’re bullish their prospects, you can buy 100 shares for $27,000 plus commissions and fees. As an alternative, you could sell one Jan $250 put option expiring two years from now for just $30. That means the option will expire on the third Friday of January two years from now and has an exercise price of $250. One options contract covers 100 shares, allowing you to collect $3,000 in option premium over time, less commission.