Selling Puts and Covered Calls
Selling puts is one of my favorite techniques for making money in the stock market. It brings in consistent cash flow and can help you achieve your goals much easier than buying options.
When you sell a put you in a sense become an insurance salesman. You agree to buy the stock at some point in the future, should the stock fall to that level or lower before a given date. For this you receive a premium up front. Selling this option to others over and over again can add up over time.
So how do you find out what to sell a put on? What I believe is that in order for a stock to be a good position to sell a put on it should be a stock with both great fundamentals and great technicals. The reason it should have great fundamentals is that you might get the chance to buy it someday.
The first rule of thumb to follow is to only sell a put on a stock that you would be willing to hang onto just in case you do end up getting put the stock.
Another favorable quality for the stock to have is high option premiums. Not all stocks are the same. Some stocks may offer huge option premiums many strikes out of the money; while other stocks may only give you $.05 for a strike price $2 out of the money. Higher premiums can help you get the most for the put and help you down the road if you own the stock and feel like selling covered calls on it.
So, let us look at an example of selling puts on a stock. I am not recommending any trade, but for illustration purposes let us say we found US Steel which is trading at $34.08 an attractive company for long term growth. We also see that the stock is in an uptrend, which is good considering the odds are that it will continue going up.
As long as we are willing to buy this stock and hold it for a while there is nothing wrong with selling puts on it. After all what is wrong with getting paid to get into a stock you already want to get into.
Once you have found a stock you have to decide what strike price to sell. Two things to consider when selling puts are.
1. The Strike Price
This should be a price you can afford to get into the position at. So if you sell the $30 strike price you better be able to buy the stock at $30 if it happens.
2. Which Month
Normally when selling puts the front month is the best time to open a new trade because that is when the option premiums evaporate the fastest, but going out further if the premium is worth it is not a bad thing.
Looking at the option chain by going down until we find the strike price and moving right to the Bid price we find out how much we can sell the option for. So if we sell the $32 put we make $1.25, and the stock would have to come down more than $2.08 before we would be put into the stock.
We also realize that if the stock does fall below $32 we would be obligated to buy it at $32, so keeping that money in reserve is a must.
Once the put is sold you can wait until it expires, or exit early by buying the put back at either a profit or a loss. By selling puts out of the money they will expire most of the time, which means the seller would receive full profits and would no longer be under any obligation.
But if the puts expire in the money you will be forced to buy the stock.
So let’s say you are in a stock, What Now? What about selling covered calls off of that stock. When you sell covered calls you give someone else the right to buy your stock from you at a given strike price on or before a given date.
This works is a similar way as selling puts, only when the stock rises above a call you sold you are forced to sell it at that strike price and exit the trade. As I wrought in 5 Times to Avoid Selling Covered Calls because selling covered calls limits your potential profit, it can be better to avoid selling them when a stock that you own is in an uptrend unless you are already happy with the profits.
I also personally prefer to rarely sell calls with a strike price less then what I bought the stock for. If the stock has dipped too far for me to receive a good premium at a strike price or higher than the price I originally paid for it, I would rather wait for the stock to come back then sell a lower call and risk getting out at a lower price. That is just my own personally feelings, some people feel differently and that is ok.Ultimately a position where you are selling covered calls on will end in 1 of 3 ways
1. You Will Get Called Out
If you keep selling calls on a stock you own, chances are you will eventually get called out. But that is not necessarily a bad thing if you have already made a good profit off of the stock.
2. You Decide to Sell
If you decide for whatever reason to sell the stock, you can.
3. The Stock Goes to $0
This is the worst case scenario anytime you buy a stock. For this reason it is important to make sure that any stock you own has a strong fundamental base.
Return From Selling Puts and Covered Calls to learn stock trading