Why do I like Selling Put Options?
Because for very little work one can generate a lot of income and positive returns that are better than normal stock market investment returns. Notice I said I am selling them and not buying them – but later you will see that I am also doing that (buying them) in one scheme I use.
When selling a put option I look for quality stock such as Apple (AAPL), Caterpillar (CAT) or Microsoft (MSFT) that shows signs of growth. Unlike buying a put option – which one would do if they thought the market or the stock was falling – I sell the put options to those who want to buy them for one reason or another. Actually there is only three reasons to buy them …
- you think the stock is going down in value, or
- you want to protect gains on the stock you already own so you buy them for insurance, or
- you are buying them to offset the selling of them in an option spread (more on this later).
All of these are subjects unto themselves. What I am talking about here FIRST is “Selling Put Options.”
Buying a Put Option is a Bearish Move while Selling a Put Option tends to be a Bullish Move. You would not sell a Put Option at or out of the money if you thought the stock was going to go down in value … you would buy the Put Option.
When selling a Put Option I also look to sell short-term puts. I am not interested in selling a put that is more than 45 days from expiration. An option will lose 50% of it’s long-term value in the last 45 days of its life. See the chart below for the 90 day option.
By selling these short-term options you take time away from the buyer and put time (or the lack of it) on your side. Since options sellers are OBLIGATED to purchase the stock in the options contract they should be favored by something other than the premium they will receive. Option buyers have rights to exercise the option … but the sellers have obligations.
It is for this reason that I will also select options strike prices somewhere between 10% and 20% below the stocks current price in an uptrending stock. This way if I am assigned the stock in the options contract (it is “Put to Me”) I will be assigned at an 10% to 20% discount from the price of the stock on the day I sold the option (and it is usually a good move to buy things on sale). Since working on this plan I have yet to have the stock assigned to me — though if it ever did occur I know that I would be getting a good quality stock and I will simply continue to generate income by selling call options against the stock (known as “Covered Call” or a “Buy-Write”).
How do you calculate return
Well there is a couple of ways to do that. You could do as some and calculate return against collateralized capital. What do I mean?
When you are selling a Put Option the broker needs to know that if the stock is put to you (if you are assigned by the buyer of the option) you have cash or margin to actually purchase the stock. Let’s say you sell the XYZ 100 Put Option. This means that if the stock is assigned to you, you would have to come up with $10,000 to purchase the stock (figured as $100 per share X 100 shares – the amount of shares covered by one Put contract is 100). If you sold 3 contracts, then you’d need to have $30,000 in cash or Margin to cover the potential cost of buying the stock at a later date.
If the stock collateral is $10,000 and the amount you receive to sell the option is say $10 per share or $1,000 – then your return could be calculated simply as 1,000 divided by 10,000 = 10%. However, let’s assume that one day before expiration you close the option out (this is done by buying an option to close it out – known as a “Buy to Close” order) and you pay just 50 cents per share to do this (or $50.00). You could calculate what I call the cash on cash return as follows: Cost out of pocket = $50.00. Proceeds into pocket = $1,000. Net gain = $950.00. So, $50 cost divided by $950 of gain = 526.32%.
Starting in March of 2020 I started to focus heavily in one of my accounts of selling Put Options Contracts as the table below shows.
If you look at the annual totals for 2020 you will see that I paid a total of $7,007.78 to close out my options contracts before expiration while taking in a total of $31,091.88 in options premiums. This provided a cash on cash return over all the options contracts of $24,086.10 or 343.71%. I am using my actual Realized Gains Table in this example.
You can see that trend has continued in 2021. I’ve closed out of four holdings in Caterpillar (CAT), Microsoft (MSFT), Apple (AAPL) and Tesla (TSLA). On these options I’ve netted cash flow of $6,996.89 against a cost to close them out of $695.91 for a profit of $6,300.96 or a cash on cash return of 905.40% so far in the first 1 month and 8 days of this year.
Here’s the problem with just selling Put Options …
In selling these options I had to have quite a bit of collateral held in the account. Here’s the calculations
- 3 Contracts on CAT at $160 Strike = $48,000 collateral required
- 3 Contracts on MSFT at $190 Strike = $57,000 of collateral required
- 4 Contracts on AAPL at $110 Strike = $44,000 of collateral required
- 2 Contracts on TSLA at $700 Strike = $140,000 of collateral required.
Since I only had $149,000 of cash in this account at the start of this year to work with … (I do have money in other investments) I had to close out the CAT, MSFT and AAPL options in order to do the TSLA options.
THIS IS HOW I CLOSED OUT THESE OPTIONS CONTRACTS AND THE REASON WHY THEY WERE NOT ALL CLOSED ON THE SAME DAY …
At the time of selling the contracts I would put a limit order in on my brokerage platform to the the computer close them out a a specified price … when and if that price was hit. For Example on CAT, MSFT and AAPL I had a price put it that was 90% BELOW the price I got for selling them.
EXAMPLE: I received about $1.25 per share for selling the MSFT options. I set the computer in a limit order to close out these options when and if the price hit $0.13 per share. Now this does not guarantee a price of $0.13 per share … it only guarantees that once that price is hit my options would be closed a the next available market price. If they closed at exactly 13 cents per share my cost would have been $39 to close out all three contracts and I received $376 for all three contracts. Thus, my profit would have been $337 or 864.10%. As you can see in this case I received a return of 889.62% on 2 contracts and a return of 890.75% on the 3rd contract.
By setting these closing orders at the time I sell the Put Options I don’t have to watch the account daily. The worst that can happen is that the option expires worthless and I keep all the premium; or the stock is Put To Me and I have to either sell it or sell Call Options against it to generate more income.
But the real problem with just selling Put Options is that one must have a lot of money available to purchase the stock if it is Put To You. Is there another way?
There is another, and potentially better, way to do this
Selling Put Spreads – Specifically Bull Put Credit Spreads …
This is nothing more than a vertical spread if you ask an option trader for the proper name. However you would do it much the same way as you would start selling Put Options.
- Look for stocks that you think will appreciate in value that you may want to sell a Put Option on
- Consider the strike price at which you would sell the Put Option
Once this is done you add one more leg to the trade. That leg would be to BUY a Put Option with a Strike Price lower than the option you are selling.
- Facebook (FB) is currently at a price of $269.37 and you think the price will continue to trend up
- You could sell the March 05, 2021 option (23 days out) at a strike price of $260.00 which would provide a premium of $4.40 (at the ASK price) = $440 would go into your account.
- You could turn around and buy March 05, 2021 (23 days out) at a strike price of $255.00 which would cost you a premium of $3.30 (at the BID price) = $330 would move out of your account.
- Your net credit would be $440 – $330 = $110.00
In this case I’d put in the mid-point credit price of $1.33 as a limit order and see if the option would trade at that. In many cases the market maker will take your request within a few minutes to an hour. If not, you can always put in a new limit order – or you can set your order to Good Till Cancelled (GTC)
If your credit price is accepted, this is what you can expect … see the figure below:
You can see in the above the $4.40 bid price and the $3.30 ask price as well as the $1.33 net credit limit price. If this price holds you will receive a net credit of $133 for each contract … so five contracts would bring in $665 and ten contracts would bring in $1,330. As the bottom of the figure shows by changing the strike prices from 255/260 t0 262.50/267.50 your could bring in about $208 per contract (using the Midpoint Price).
What is your maximum loss potential?
The difference between the strike prices of the two options less your credit. In this case it could be as low as $500 – $133 = $367 per contract. In other words you are risking $2.76 for every $1.00 of gain. That is a risk to reward ratio of 2.76:1.00 – not bad considering most are looking for risk to reward ratios of 5:1 or lower.
Your break-even on this trade is $258.67. In other words in the next 23 days FB stock would have to drop by $10.70 per share before the trade would not be profitable for you.
Capital required for this trade:
If you were simply selling the PUT Option on FB at $260 per share … you would get income of $440 per contract … but you would have to have on deposit or in margin a total of $26,000 per contract $260 per share times 100 shares). If you were going to do 10 contracts you would have to have $260,000 in reserve and you would net an income of $4,400.
However, by doing this vertical spread, you would only need to have $500 in reserve for each contract. That is calculated as the difference between the strike prices ($260 – $255 = $5 x 100 shares = $500). Therefore, 10 contracts (1000 shares) would require you to have $5,000 in collateral. This is a lot less than the $260,000 that would be required simply for selling 10 Put Contracts on FB.
Your maximum gain on this Vertical Spread (the Bull Put Credit Spread with ten contracts) would be $133 x 10 contracts or $1,330. If we divide this amount by the collateral required your looking at an instant return of 26.60% for an investment requiring you hold it for a maximum of 23 days (you could always close it out earlier)
On the other hand, by simply selling the ten contracts and obtaining the $4,400 against total collateral of $260,000 you would be looking at a return of only 1.69% ($4,400 divided by $260,000). Annualized that would still be a solid return of 26.82%; but …
The 26.20% return on the 10 contracts of the Bull Put Credit Spread would be an annualized return of 415.78%.
I wonder what would happen if we did 34 contracts on this one?
Let’s See …
- 34 contracts at $1.33 would bring in $4,522 (a little more than 10 Put ONLY contracts that were sold)
- Capital required for 34 contracts would only be ($5 x 3,400 shares = 17,000). Compare this with the $260,000 required for the PUT only option.
The Bottom Line:
If you are interested in owning a stock at a discount you have two options:
- Put in a limit order to purchase the stock at some price lower than it is now and keep the money in cash earning .05% or less until that price is reached, if it is reached, or
- Sell a Put Option with a strike price that you would be willing to pay for the stock and collect a premium of much greater than .05% on your capital while you wait for the stock to get put to you at that price. If it does not reach that price … keep selling Put Options until it does.
If you are not necessarily interested in owning the stock and want to generate cash flow on less money than is required to simply sell Put Options …
- Use the vertical options spread known as the Bull Put Credit Spread and sell one Put Option at a higher strike price and purchase one Put Option at a lower strike price to get money put into your account.
- Keep the timing of these options to 30 days or less and continue this trend each and every time they expire.
- In the words of Ole Ben Franklin, “You’ll be adding a little to a little and after while you will have a lot.”
It is important that you study and commit to learning options before you jump in and start doing them. However, take it from one who knows … the best lessons will be those that you learn by putting some “Money in the Game.”
You can Google “Investing in Stock Options” or “Bull Call Credit Spreads” and get a pages and pages and videos on top of videos on how to do this. Never stop learning! Here’s a video to get you started: https://www.youtube.com/watch?v=anUCpioZ2TA
My Account (Review Figure Below):
On January 26th of this year I did a Bull Put Credit Spread on Fulgent Technologies (4 Contracts). At the time of doing this I chose and expiration 24 days away (02/19/2021). I sold the $65 strike for $2.70 and bought the $60 strike for $1.42. The net income to my portfolio was $1,076.33 that I was paid to sell a Put Options (shown in red) minus the $569.64 that I paid to purchase the Put Options (shown in gree) for a net cost of +$503.69. The confusing part of this from all brokerage firms is that the money you are paid is shown as a negative in red because you are “Short” this position. You can see these numbers under the Cost (Total Avg) Column. Looking at these numbers today under the Position Dollar Column and the P&L Column … the value of the $65 Strike is -$100 providing a profit of $976.33 and the value of the $60 Strike is $40 giving me a loss of -$529.64 for a net value of $444.02 (ONLY if I chose to close out the position today).
On February 3, 2021 I did a Bull Put Credit Spread on Pintrest Inc. where I sold the $68 Put and purchased the $63 Put. I received $2,284.31 for selling the 7 contracts of the $68 Put and paid $1,271.64 for buying the 7 contracts of the $63 Put for a net profit into the account of $1,012.67. The net value today (Position Dollar Column) is $2300 – $1260 = $1,040 (ONLY if I chose to close out the position now).
Then on February 5, 2021 I did 6 more Bull Put Credit Spreads on 3M Company, Adobe, Inc., Aptiv PLC., Microsoft Corp., Skyworks Solutions, and Teradyne Inc. The total net income received on these 6 spreads was $7,753.48. If you add up all the numbers in the Cost Column (not counting the $22,693.16 for Nuveen Nasdaq 100 Dynamic Fund — will explain later) you come up with a total of … $9,272.84. That is not a bad income over a period of less than 1 month.
Now for the Nuveen Nasdaq 100 Dynamic Fund (Symbol QQQX). This is where I tend to park money received from selling PUT OPTIONS. I could keep the money in cash … but cash in this account pays less than 0.05%. This fund – which is based off the NASDAQ 100 Index – pays a dividend yield alone of 6% or more and has growth potential. Therefore I really don’t consider the cost of this fund as the cost is provided by “by other peoples money” that pay me to sell them a PUT Option. I do consider the value, though, as that is My Money for taking on the investment risk of selling PUT Options.
With total portfolio value of over $166,000 I now only have $65,500 tied up as collateral for all these Bull Put Credit Spreads … which means I still have about $100,000 or so to invest when opportunities arise. Buy selling Put Options ONLY – I would not have money to take advantage of unknown opportunities if all my money was tied up covering the Put Options.
I can’t wait until about the 20th of this month to see what my total gains are for the options year to date. If I get to keep all my premiums on the batch I currently have set to expire on 02/19/2021 – when added to what I’ve already created in realized gains (first graphic shown) I should end up with gains of about $15,573.80 after just two months. If I can keep this trend up … it could be as much as $93,000 or more in added income by the end of the year. Not bad with a portfolio currently valued at about $166,000. We’ll just have to wait and see which is the real fun of investing.
While I own stocks or options on all the investments discussed, I am not recommending any of these to you at this time. This article was put together for educational purposes only. If you have any questions please feel free to list them in the comments below or email me at email@example.com