Put Option Writing
This is a seldom talked about strategy, but it's very popular with professional investors and seasoned options traders alike.
But while not too many people have heard of it, it's easy enough that virtually anybody can do it if their account is set up for it.
To illustrate this, I'm going to go over an actual trade of mine to show you how easy it is to do and walk you thru how it works.
But first, let me review a few things on puts: in general, a put option increases in value as the price of the underlying stock goes down.
A put option gives the buyer the right, but not the obligation, to sell a stock (100 shares) at a certain price within a set period of time. The put buyer pays a premium for this right.
The put seller (or writer) is obligated to buy that stock at a certain price within that same period of time. The put writer collects a premium for this obligation to potentially have to buy the stock.
In this example, I'm the put writer.
(Essentially, the writer is getting paid to write a put option. They may have to buy that stock later, but they're still getting paid to write the put.)
The benefits are this: if you write a put option (let's say an out-of-the-money put option), and it goes down, but let's say not as far down as your strike price, your profit will be the entire premium you got paid for writing the option.
If it does go down to your strike price, and it's a stock you wouldn't mind owning, you'll now get the chance to own that stock at a cheaper price than what it was currently trading at when you wrote that put option in the first place. And don't forget, you still got paid that premium.
The risk of course is that if the stock goes down far enough and you decide you don't want the stock, you'd then have to buy the option back at a higher price to get out of the trade.
Or the stock could be put to you at a price that's higher than the market and you now have a loss on the stock.
(But if the stock is put to you, you're basically taking on the same kind of potential risk as a normal stock trade, except you also got paid a premium too.)
So let's look at the trade.
On December 3, 2008, I decided to write a put option on Apple (AAPL - Analyst Report).
And I chose the April, out-of-the-money $70 Put Option at a premium of $8.35 or $835.
AAPL was selling at approximately $93 at that time and I believed that AAPL would go up or at least not go down much below $70.
At the time I did this, the bear market was in full swing and I didn't have enough conviction that APPL would go straight up, so I didn't want to commit $9,300 to get long 100 shares of AAPL.
But I also didn't want to miss out on an opportunity to make money in AAPL because I thought I had correctly identified its general range and wanted to profit from that.
But I also thought that if it did go down to $70, I wouldn't mind owning AAPL at that price. But if it never got there, I'd still get paid a premium in the meantime.
So, on December 3, I wrote the April $70 put at $8.35.
Which means, if AAPL stayed above $70 at expiration (the third Friday of April), my gain would be the full $835 I collected.
In fact, even if the market went below $70, to even as low as $61.65, I still wouldn't lose anything.
Why?
Let's do the math.
- If AAPL is at $61.65
- And the stock was put to me at $70
- That's an $8.35 loss
- But, I also collected an $8.35 premium for writing the put
- Which means, even though the stock is below my $70 purchase price, the put premium offset my stock loss, meaning I now have the stock and I'm even on the trade.
Only if AAPL is below $61.65 at expiration, am I starting to lose original principle.
I should also mention that this is better than a buy stop because if I got filled at $70 and it went down to $61.65, I would be down $8.35 because I didn't have any put premium to offset it.
Anyway, since the time I placed that trade, the price of AAPL got as high as $124.25 and as low as $78.20.
On 4/17/09, that April option expired 'worthless' which means my profit was the full $835 premium I collected (less my $10.75 commission), for a 98.7% return.
Now, in hindsight, with AAPL trading at over $124 at the time of the option expiration, had I gotten in at $93, I would've been up $31 or $3,100.
But before it got as high as $124.25, it first got as low as $78.20 while the bear market was at its worst.
If I had the stock, I would have been down as much as -$1,480 or nearly -16%. And it's likely I would have gotten out of that trade at a loss and potentially missed the chance to be in on the run-up.
But with the written put option, the trade remained profitable virtually every day from its inception, even when the market was down, which means I never had to second guess the trade once.
That trade turned out to be virtually picture perfect.
And you can do it to.
And the best part is, you don't even have to be right on the direction, just the general range.
I like writing options on higher priced stocks as I find there's a bigger premium to be collected.
I used one of my AAPL option trades as an example because it's probably one of my favorite stocks to both buy and sell options on. I'm also partial to Amazon.com (AMZN - Analyst Report) as well.
Another good stock to consider for option writing (or buying) is Google (GOOG - Analyst Report).
Do your own research on this strategy and see if it's right for you.
You can also learn more about this strategy and other option strategies by downloading our free options booklet: 3 Smart Ways to Make Money with Options (Two of Which You Probably Never Heard About). Just click here.
Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.