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Selling Put Options Guide – Understand Risk vs. Rewards & How to Profit

Options are a type of financial derivative that gives investors the opportunity to buy or sell the right to buy or sell a stock at a set price.

While trading options can be complex, they’re useful because they let investors profit from various predictions about a stock’s future price movement in cases where simply owning the stock wouldn’t let them make money.

Put options, in particular, let investors buy or sell the right to sell a specific stock at a set price. Some investors choose to sell put options as part of their trading strategies.

Basic Terms to Know

  • Sell or Write a Put. Selling or writing a put option means selling someone the right to sell you a specified stock at a specified price. As the seller of the put, you are obligated to purchase the shares at the agreed price if the put’s buyer exercises the option.
  • Buy a Put. Buying a put means paying someone else for the right to sell them a specified stock at a specified price. As the buyer of the put, you have the right to exercise the contract and sell the shares at the strike price.
  • Strike Price. The strike price is the price specified in the option at which you will buy or sell the stock.
  • Expiration Date. The expiration date of an option is when the option contract becomes invalid and therefore worthless. The buyer of the option must choose to exercise it before the expiration date.

Pro tip: If you’re looking to start trading options, make sure you sign up for the Motley Fool Options community. Not only will you receive options trading recommendations from the experts at Motley Fool, but you will also be joining a community of like-minded investors.


What is a Put Option?

A put option gives the option holder the right, but not the obligation, to sell a stock or exchange-traded fund (ETF) at the strike price set in the option. Typically, an option controls 100 shares of the underlying stock.

For example, you might sell someone a put option for 100 shares for XYZ with a strike price of $50 and an expiration date of July 31. At any point between buying the option and July 31, the buyer of the option can opt to exercise it and sell you 100 shares of XYZ for $50 each.

Typically, the buyer of the option will only exercise the option if the stock price for XYZ is below $50. That will let them buy the shares on the open market and immediately sell them for a profit.

Put sellers receive a payment from the put buyer, called a premium. The seller gets to keep the premium no matter what, even if the put buyer does not exercise the option.

For more information on how trading options contracts works, check out our guide to the basics of call options and put options.


Why Would an Investor Sell Put Options?

Investors consider selling put options for a few different reasons.

Earn Income

Like many options trading strategies, selling put options is one way for investors to generate income.

When you sell a put option, the buyer pays you a premium. Even if the buyer does not exercise the option, you get to keep the premium payment. The larger the premium, the more income you receive.

If the buyer does not exercise the option, your profit is equal to the entire premium. If the buyer exercises the option, your profit or loss will be equal to:

((market price – strike price) * 100) + premium received = profit or loss

Selling put options on a stock that you expect to hold steady or increase in value lets you earn income with only limited risk.

Purchase Shares When They Reach a Set Price

Some investors, especially long-term investors, research different stocks and come to a conclusion about their fair value and the price they’d be willing to pay for those shares. Selling put options gives these investors a way to buy into a stock when it falls below a set price.

For example, if XYZ is selling for $50 and you know that you’d be willing to buy into the stock when it costs $40 or less, you could sell put options with a strike price of $40. If the stock ever drops below $40, the option holder will likely exercise the option and you’ll buy the shares at $40 each.

The upside of this strategy is that you get to earn income from selling puts in the time before the share price reaches the price at which you’re willing to buy shares. The drawback is that if the price falls far below your target price, you’ll ultimately overpay for the shares.

If in the example above, the stock fell to $30 per share, you’d still pay $40 per share when the option holder exercises the option, meaning you’d pay more than you could have paid on the open market. However, if you plan to hold for the long-term, you can still earn a profit in the end as the stock gains value.


Benefits of Selling Put Options

There are many advantages to selling puts.

1. Profit in a Sideways Market

If you buy shares in a company, you only turn a profit when those shares increase in value. One advantage of selling puts is that investors can use the strategy to earn a profit when the price of a stock doesn’t rise or fall.

With a put, you receive the premium when you sell the contract. So long as the strike price of the contract is below the current market price, the buyer likely won’t exercise the option if the price of the underlying security holds steady, remaining above the strike price.

This gives investors more choices for earning a return than simply buying shares.

2. Limited Risk

Many options strategies have theoretically unlimited risk, which makes them a scary proposition to everyday investors. However, like covered calls and a few other options strategies, selling puts has limited risk. If the market price of a stock or ETF drops to $0, the absolute most you can lose from selling a put option is:

(100 * number of contracts * strike price) – premium received = worst possible loss

This is still a notable risk, but it’s comparable to the risk you assume when you buy 100 shares of the underlying security at market value. Unlike some other derivative investments, you can never lose more than the value of the shares you agree to buy.

3. Potential for Appreciaton

The failure case for selling a put option is if the option buyer exercises the option and sells shares to you above their market value.

Once assigned, though, you can simply hold onto the shares. If you already wanted to include those shares in your portfolio as part of your investment strategy, there’s nothing forcing you to immediately sell them as part of fulfilling the contract.

If you wanted to own the stock for the long term anyway, you can keep it in your portfolio and wait for its price to appreciate. In the end, you could sell the shares for a profit, recouping your losses on the option.


Risks of Selling Put Options

Before you start selling puts, you need to be aware of the potential risks and drawbacks.

1. Leverage Increases Potential Losses

Options strategies let investors leverage their portfolios, gaining control over a large number of shares at a low price.

Most options contracts involve 100 shares of the underlying stock or ETF but cost much less than 100 shares on their own. Leveraging your portfolio means higher gains when you turn a profit, but also leads to larger losses when your plans fail to pan out.

A $1 change in a stock’s price can equate to $100 in additional losses on a single put option if the buyer exercises it, so it’s important for investors to be prepared for potentially large losses.

2. Margin Calls

One major risk related to the leverage involved in using puts is the risk of a margin call.

If you sell put options but don’t have the funds in your account to cover the cost if the option buyer were to exercise them, your brokerage will want to know you can afford to pay for the shares you’ll need to buy. They’ll keep track of the liability created by the put options you’ve sold.

However, there are limits on how much money a broker will let you borrow. The amount is related to the value of your account.

If the market drops and you wind up with a large potential liability due to puts you’ve sold, your broker might make a margin call, forcing you to put more money in the account to cover your liabilities.

If you can’t come up with the cash to meet the call, your broker may force you to sell other investments, even for a loss, to cover the liability.

3. Limited Potential Profits

When you sell a put, the buyer pays you an option premium. The payment you receive is the maximum profit you can earn from the transaction. Other options strategies and investing strategies have much higher profit potential than selling puts.

Typically, the maximum potential profit from selling a put is much lower than the potential loss if the stock falls to a lower price. Investors need to keep the mix of risk and reward in mind when selling puts.


How to Sell Put Options

If you’ve decided that selling put options is the right strategy for you, the first step is to open a brokerage account. There are many brokerages that offer options trading, so you’ll want to compare factors like the fees they charge and which one has the interface you like the best.

Next, you’ll want to think about the type of security you want to sell puts for. Typically, you can sell puts for stocks and ETFs. You should feel confident that the security you choose is poised to maintain its value or gain value.

Remember that you profit when the price of the security rises or stays the same and lose money when it falls below the strike price of the option.

In general, selling puts on securities experiencing more volatility will let you command higher premiums and therefore higher potential profits.

Once you’ve chosen a security, it’s time to choose the strike price and expiration date for your option. Generally, you can charge higher premiums for higher strike prices and expiration dates further into the future.

The higher the strike price of the option, the less the stock’s value has to drop for the buyer to profit.

Similarly, the more time between the sale and the expiration date of the option, the more time there is for the stock price to fall below the strike price. Put sellers are compensated for these increased risks through higher premiums.

Once you’ve chosen a security, strike price, and expiration date, you can place the sell order through your brokerage account.


Example of Profit and Loss From a Put Option

When you sell a put, you earn a profit (your collected premium payment) when the price of the underlying asset remains at or above the strike price of the option.

For example, if it is February 1 and XYZ is trading at $50, you may sell a put option with a strike price of $40 and an expiration date of June 30. Imagine you receive a premium payment of $85 for selling this put.

If the price of the stock remains above $40, you’ll earn a profit of $85, equal to the premium you received. Your profit does not change no matter how high the stock’s price rises.

If the stock price falls below $40 and the option holder exercises the option, you’ll lose $1 for each penny the stock drops below $40. Remember, each option covers 100 shares of XYZ, so a difference of one penny in the stock price means losing 100 pennies, or $1.

Recall the formula for calculating profit or loss when a put you sell is exercised:

((market price – strike price) * 100) + premium received = profit or loss

If the stock falls to $39, you’ll have to pay $40 per share when the option is exercised and can sell the shares on the open market for a loss of $100. Your overall loss is:

($39 – $40) * 100 + $85 = -$15

If the stock falls to $35, you’ll lose:

($35 – $40) * 100 + $85 = -$415

The more the share price decreases below the strike price, the greater your losses will be.


FAQs

Is Selling Puts Safe?

As far as options strategies go, selling puts is relatively safe, but it is not the safest options strategy. The losses can be significant given the amount of leverage inherent in options, but there is no possibility of theoretically infinite loss.

Is Selling Puts a Bullish or Bearish Strategy?

Selling puts is a bullish strategy because you earn a profit if a stock’s price remains high and lose money when the price falls.

Are Puts or Calls More Profitable?

Whether calls or puts produce a greater profit depends on the performance of the underlying security and the exact option you sell. There isn’t a single answer to whether you’ll earn more from puts or calls.


Final Word

Options offer investors a way to leverage their portfolio and profit from situations where simply owning shares in a company wouldn’t help them make money.

While selling puts is a relatively simple strategy, there are safer options, such as selling covered calls, for those who want to produce income from their portfolio. If you’re interested in trading options, starting with these less risky strategies is one of the best ways to learn.

TJ Porter
TJ is a Boston-based writer who focuses on credit cards, credit, and bank accounts. When he's not writing about all things personal finance, he enjoys cooking, esports, soccer, hockey, and games of the video and board varieties.

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