Selling Put Options Example (Writing Naked Puts)
When you sell put options, you are hoping that the put options expire worthless. Generally speaking, you want your put option to expire out of the money and hence be worthless on the expiration date. For the put options to expire worthless, you’d want the price of the underlying security to increase. That’s because when the price of the underlying security decreases, the value of the put option increases. When that happens, you may be forced to close the position and buy back the option contract at a higher price, resulting in a loss. So when you decide to sell a put option, make sure that the underlying security price has an upward bias for the duration of the trade.
Let us consider an example. An options trader is positive that the markets and the price of an underlying security will rise beyond the consolidation range of $60 – $62. The options trader writes a Jan 57.5 put and collects a total premium of $200. The price of the underlying security stays within the range of $60 – $62. However, over time, the value of the option has eroded. Now the same put option fetches a total premium of $50 as it nears expiration. The options trader offsets by buying to close the position, netting himself a profit of $150 before commissions.
Writing naked puts is a limited profit strategy. Losses are limited but can be substantial as the price of the underlying security can fall to 0.
When to Sell Put Option?
When a trader arrives at an assessment that the markets and the underlying security are moving upwards or constant in general, the trader can consider selling put options. This assessment can be arrived at through economic, fundamental and technical analysis.
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