Writing Puts to Purchase Stocks

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How to sell secured puts

Do you use good-til-canceled (GTC) limit orders to bid for stock below the current market? Many investors do. After deciding they are going to buy a stock, many investors will place a bid below the current market price, hoping for a dip in the stock price. This way, if they end up buying the stock, they feel as though they got the best deal possible.

Rather than waiting for a stock to hit your target purchase price, however, you might consider using options to collect money today for being willing to assume the obligation of buying stock if the stock moves to the lower price that you choose.

It may seem a little counter-intuitive, but investors can use short puts toВ buyВ stock. This options strategy is referred to as the cash-secured put.

  1. Find a stock (or ETF) you would like to buy.
  2. Determine the price at which you’d be willing to purchase the stock.
  3. SellВ a put option with a strike price near your desired purchase price.
  4. Have on deposit in your brokerage account an amount of cash equal to the potential obligation.
  5. Collect (and keep) the premium from the sale of the put, while you wait to see if you will buy the stock at the lower price.

Let’s take a look at the possible outcomes of this strategy. If the stock price goes up or remains unchanged, you won’t buy the stock, but you do keep the premium you collected from selling the put. If the stock price is below the strike price at expiration, you will buy the stock at the strike price, and you keep the premium you collected from selling the put.

The risk when selling cash-secured puts is if the stock price falls significantly below the strike price. Since you are obligated to buy the stock at that strike price, you would be purchasing stock above then current market value. This is also true of placing a GTC order below the market; if the stock price drops significantly, you will buy the stock at or below the lower price if the stock continues to move lower.

There are some differences between a cash-secured put and a limit order bid below the market. First, with the cash-secured put your effective purchase price of the stock is reduced by the premium you collected from selling the put and second, if the stock price doesn’t get down to your desired purchase price, with the cash-secured put you are still collect a premium. However, if negative news were released when the market is not open, an open limit order can be canceled if you no longer want to buy the stock; if you have a cash-secured put and you want to avoid the obligation to buy the stock, you would have to wait until the market is open to close that position.

Example trade

Let’s assume stock XYZ is currently trading for $96 per share. You would like to buy 200 shares of stock XYZ if it drops to $90. You could place a GTC limit order to buy 200 shares at $90 and wait to see if you buy the shares. Or, you could sell two XYZ 90 puts at $2.25 and collect $450 (2 X $2.25 X 100 = $450) on your willingness to buy 200 shares at $90. With the cash-secured put, you can generate additional returns in your portfolio by collecting a premium minus commission for your willingness to be obligated to buy a stock at a price that is below current market.

One question many traders may ask is, “How does someone choose what strike price to sell?” Ask yourself, at what price would you be willing to buy the stock? While that may be a simple answer, it may not be easy! To help traders decide, there is a mathematical tool available to you. That tool is called Delta.

What is delta?

There are three definitions of delta, which are all true. It is the expected change in the value of an option’s price for a $1 move higher in the stock price; it is the percentage of price risk of stock ownership that is currently represented in the option; and it is a model-based calculation of the approximate probability that at expiration the stock’s price will be lower than the option’s strike price, and you will be obligated to buy the stock.

The third definition, in particular, is oftentimes a useful indicator to help determine which puts sell.  You can use the option’s delta to determine the chance you will end up buying the stock. If you want a lower probability of having to purchase, you could consider selling lower delta puts; if you wanted to increase that probability you could consider selling higher delta puts.

Once you have decided which puts you want to sell, and you have sold them, you do need to monitor your position. It is important to note that you do not need to wait until expiration to see what happens; you can always unwind, or close, your options position before expiration. Just because there’s an expiration date attached to the options trade, does not mean you have to hold it until that date. If the trade is profitable and you want to take your profits earlier than expiration, then do so! Conversely, if you experience losses on the trade and you want to limit further losses, you can always close the trade.

The cash-secured put is a powerful options strategy that may help you generate income on your willingness to bid for stock below the current market.В Open an accountВ to start trading options orВ upgrade your accountВ to take advantage of more advanced options trading strategies.

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Writing Puts to Purchase Stocks

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Invest in Stocks by Trading Sell to Open Put Options

One of many options trading strategies, selling open put options could, if executed under the right market conditions, generate high profit. The strategy tries to capitalize on lower stock prices. Although the market offers no guarantees, this strategy could reward you with some profitable returns on unleveraged equity in an extremely volatile market. Novice traders should understand that the strategy also represents high risks.

Fear in a Falling Market

Many investors feel uneasy when the stock market starts heading down, and if the trend continues, they start to feel outright panic. Suddenly, people want to sell off their shares quickly to avoid any further drops in stock prices and the resulting hit to their portfolio’s value. As an options trader, you can take advantage of this down-market volatility to help investors curtail their losses while also earning a potential profit for yourself.

If you’re a seasoned trader, this process allows you to leverage the knowledge you’ve already acquired about various businesses through your years of studying various annual reports, 10-Ks, and other SEC filings.

For Comparison: A Regular Stock Buy

Let’s say that at some point in the past, you had wanted to purchase Tiffany & Co. shares because they have great brand recognition, and they operate using a fairly simple business model. However, you weren’t sure how to proceed since the current market was experiencing high volatility and you had seen falling stock prices over an extended period.

For example, as of the close of markets on October 14, 2008, shares of Tiffany & Co. were selling at $29.09 each, down from a high of $57.32 prior to the crash on Wall Street. Investors were panicked that the retail environment was going to fall apart and that high-end jewelry was going to be one of the first things to go because consumers weren’t going to buy expensive watches, diamond rings, and housewares when they couldn’t even pay their mortgage.

Assume you had long wanted to own stock in Tiffany & Co. and had been waiting for just such an opportunity. In a persistent down market, the stock could very well fall another 20 percent, 30 percent, 501 percent or more, but you want to profit from your ownership of Tiffany’s stock for the next 10 to 20 years. There could be a way to take advantage of the current situation without actually buying the stock, while also generating some nice returns for your portfolio.

In one scenario, you could just buy the shares outright, pay cash, and let them sit in your account with dividends reinvesting. Over time, according to 200 years of history on average stock market returns, you should experience a comparable rate of return to the performance of the underlying business.

Thus, if you wanted to buy 1,000 shares of Tiffany’s stock, you would take $29,090 of your own money plus $10 for a commission, and use the $29,100 to buy the stock at the October 14, 2008, market price of $29.09 used for our example.

An Alternative Strategy

A more interesting, and perhaps more profitable, scenario using an options strategy can also put your capital to work. Using a special type of stock option, you can create something akin to writing and selling an “insurance policy” for other investors who are panicked about a potential crash in Tiffany & Co.’s stock price.

Put options give the option buyer the right to “put” the stock to the option seller for a predetermined price, typically a higher price than the current market price, good up until a predetermined date. “Sell open” means that you are selling the put options short. To illustrate the “short” concept, if you sell the stock short this means you borrow it from your broker and sell it to another investor without owning it.

For the strategy to work, you must sell it at a higher price, and then buy the stock at a later time, at a lower price from your broker and keep the profit, assuming the market goes down. Selling put options open, or short works the same way.

The buyer of the options is never obligated to exercise his right to sell their stock, but when the stock price keeps dropping, the option provides the investor with the ability to sell at a set price. This protects investors by letting them get out of their stock position before it loses too much value.

For example, say an investor was willing to pay for an “insurance premium” of $5.80 per share if you, the option seller, agrees to buy his Tiffany stock from him if the price falls to $20.00 per share. You would create this insurance policy by selling, or writing, a put option contract that covers 100 shares of Tiffany & Co. stock. By writing this contract, you would agree to sell another investor the right to force you to buy his Tiffany shares at $20.00 each, any time he chooses between now and the close of trading on the day in which you’ve chosen for this put option to expire.

In exchange for writing this “insurance policy” that protects the investor from a large drop in the price of the jewelry store shares, he pays you $5.80 per share. This payment becomes yours forever, whether or not the buyer exercises his contract, or in other words, forces you to buy his stock.

The Scenario Illustrated

Say you took the $29,100 that you would have invested in the stock by buying shares outright and instead agreed to write insurance for another investor or “sell open” some put options on Tiffany & Co. shares with an expiration date of the close of trading on Friday one year from today, at a $20.00 strike price. The strike price represents the price at which the option buyer can force you to buy the stock from him.

You contact your broker and place a trade for 20 put option contracts. Each put option contract represents “insurance” for 100 stock shares, so 20 contracts cover a total of 2,000 shares of Tiffany & Co. stock.

The moment the trade executes, you’ll earn $11,600 of cash for your options, minus a broker commission. It’s your money forever and it represents the premium the other investor, or option buyer, paid you to protect him from a drop in Tiffany’s stock price.

If Tiffany’s stock price falls below $20 per share between now and the option’s one-year expiration date, your put option contracts might require you to purchase 2,000 shares at $20 per share for a total of $40,000. On the upside, you’ve already received $11,600 in premiums. You can add the $11,600 to the $29,100 cash you were going to invest in Tiffany & Co. common stock, for a total of $40,700.

Because of the put options you sold, you have a $40,000 total potential commitment to your put option buyer, minus $11,600 in cash received from him, equaling $28,400 remaining potential capital you’d need to come up with to cover the stock purchase price if the options are exercised. Since originally, you were to spend $29,100 buying 1,000 shares of Tiffany & Co. stock anyway, you’re fine with this outcome.

You immediately take your $40,700 and invest it in United States Treasury Bills or other cash equivalents of comparable quality that generate some low-risk interest income. This cash stays there as a reserve until the put option contracts expire.

In this scenario, the company’s stock stays strong, the buyer never exercises his options and the expiration date comes and goes. The put option contracts expire; they no longer exist. You keep the money the buyer paid you for the “insurance premium” forever, and essentially, in exchange for putting $28,400 aside in Treasury bills for a year, you were paid $11,600 in cash. That’s quite a nice return on your capital for the one-year duration of the put option contracts.

The Strategy Changes If the Buyer Exercises His Puts

In the opposite scenario, say your options buyer gets anxious at Tiffany & Co.’s dropping stock price, exercises his options, and you now have to buy 2,000 shares of Tiffany & Co. stock from him at $20 per share for a total cost of $40,000. Remember, however, that only $28,400 of the money was your original capital because $11,600 came from the premiums that the buyer of the options paid to you for writing the “insurance.” This means that your effective cost basis on each share becomes only $14.20 ($20 strike – $5.80 premium = $14.20 net cost per share).

Recall that you were originally considering buying 1,000 shares of Tiffany & Co. stock outright at $29.10 per share. Had you done that, you’d now have some large unrealized losses on the stock. Instead, because of the options being exercised, you own 2,000 shares at a net cost of $14.20 per share. Since you wanted the stock anyway, planned on holding it for 10 or 20 years, and would have been in a huge unrealized loss position were it not for the fact that you chose to write the options, you now ended up with the Tiffany & Co. stock you wanted, at a $14.20 cost basis instead of a $29.10 cost basis.

The Outcome and a Word About Risk

In the highly unlikely event, the company goes bankrupt; you’d lose the same as if you’d bought the stock outright. Barring that outcome, if the buyer exercises his options, you get the stock at a reduced cost basis, and you’ll also keep the interest earned while you had the money invested in Treasury Bills. That kind of advantage is very substantial, as even small differences in returns can result in vastly different earnings results over time due to the power of compounding—an investor that gets an extra 3 percent each year, on average, over 50 years could have 300 percent more money than his contemporaries. While speculative and not without risk, these types of transactions can offer the potential for good returns as market volatility increases.

Speaking of risk, this strategy is not recommended for any but the most seasoned investors. Sellers just learning how to sell options can become intoxicated by the large cash receipts deposited into their account from “insurance premium” payments, not realizing the total amount they need to deposit in the event all of the put options they sold were exercised. With a large enough trading account, you as a trader might have a substantial enough margin cushion to buy the shares anyway, but that could evaporate in the event of another round of widespread market panic. In that case, you would find yourself getting margin calls, logging in to see your broker had liquidated your stocks at massive losses, and witnessing a huge percentage of your net worth wiped out, with nothing you could do about it.

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What is the meaning of “writing put options”?

A long position in a security, such as a stock or a bond, or equivalently to be long in a security, means the holder of the position owns the security and will profit if the price of the security goes up. An investor goes long on the underlying instrument by buying call options or writing put options on it.

I wonder if “write” means “sell” and “read” means “buy”?

Now come to the meaning of “writing put options” in the quote. If interpreting “write” as “sell”, “writing put options” means selling the put option. But it is the buyer of a put option not the seller who has the right to choose whether to trade the underlying instrument in the future, and therefore the seller cannot be benefited from the price of the underlying instrument increasing. So I wonder if “writing put options” means selling the put options or selling the underlying instruments?

5 Answers 5

“Write” means sell to open. It is called that because options writers are creating (i.e. writing) new contracts. No such thing as “reading” an option.

Apple closed Friday 9/23 at $403.40.

This is what the Puts look like, note the 2020 expiration. (The rest is hypothetical, I am not advising this.) As a fan of Apple and feeling the stock may stay flat but won’t tank, I sell you the $400 put for $64.65. In effect I am saying that I am ready willing and able to buy aapl for $400 (well, $40,000 for 100 shares) and I have enough margin in my account to do so, $20,000. If Apple keeps going up, I made my $6465 (again it’s 100 shares) but no more. If it drops below $400, I only begin to lose money if it goes below $335.35.

You, the put buyer are betting it will drop by this amount (more than 15% from today) and are willing to pay the price for this Put today.

“Writing a put” for a stock means you are selling the right to sell you stock.

Simply put (er no pun intended), “writing put options” means you are selling somebody else the right (a contract) to sell YOU a specific stock at a specific price before a specific date. I imagine the word “write” to refer to the physical act of creating a contract.

The specific price is called the STRIKE and the specific date is the EXPIRATION. By “writing a put”, you are agreeing to purchase the stock at a particular price (the STRIKE price) before the expiration. You get paid a fee, the “premium“, for agreeing to purchase the stock at the strike price if asked to. If the holder of the contract decides to make you buy the stock at the strike price, you have to do it.

If the stock never dips below the strike price, then the holder of the put contract (a contract you wrote), will never exercise their right because they’d lose money. But if the stock drops to zero, you could potentially lose up to your strike price (times the number of shares at stake), if the holder of the contract decides to exercise.

Therefore, “writing puts” is a LONG position, meaning you stand to gain if the stock goes up. FYI – “LONG” refers direction (UP!), not duration.

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