"I'm new to the 'sell the put' strategy and there's something I don't understand: If ABC is falling and you don't wish to own the stock, you can come up with some more money and buy yourself out of the puts you sold and be done with it for a small loss." "Can you give an example of this?" Here goes: When you sell a put, you are giving the market the right to "put" the underlying stock to you at a specified price. So, say ABC is trading at $70 and looking strong. The stock seems like it's going to continue higher. The 65 puts were a buck fifty, and you sold 10 contracts of them. So, you took in $1500. Now what you have done is given the market the right to force you under contract to buy ABC "at" 65 bucks, even if it falls to 60. Granted you sold those puts because you believe that ABC is going to either continue higher or at least stay where it's at. If it does that, you take in the $1500, the options expire, and you made money. But what if it does't rise. The SEC says there is fraud, whatever. The bottom line is that it is falling instead of going up. Now, if it stays above 65, you have no worries. But what if it looks like it might fail 65 dollars? Well you've entered into a contract saying you'll buy it at 65. If you do nothing, that stock will be "put to you". So, the way to get around buying 1000 shares of ABC, is to "buy back" the puts you sold. When you buy back your sold puts or calls, the contract is cancelled out. The play is over. So what's the catch? The catch is that you sold the puts for a buck and a half, but now they are say $7. So, you have to make a decision. Would you rather pay $7000 and get out of this trade, or do you want to buy 1000 shares of ABC at 65? Some will be happy taking the stock. That's why it's a pretty good way to get stock a bit cheaper if you really want them. If a stock is $70.50 and you sell the 70 put and take in $2, if it falls to 69.90 and gets put to you, great! You wanted it anyway, and you got paid to take it. If however you were selling the puts as a profit play, then of course you have to manage that position. Just like using stops on a stock play, you never want your options play to get away from you. If you took in say $1.50 on selling the puts, maybe you decide that if they rise in value to $3 you will buy them back. Everyone has their own strategy for this, but you do need to go into a put sale with an idea of what sort of risk you are going to allow yourself. |
