Selling Cash-Secured Puts
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Scenario:
Ace plans to buy 100 shares of GOOG 0.00%↑ at $100 and the current price is $116 (As of 31 Jul 2022). He places a Limit Order at $100 and waits patiently day after day, week after week for the price to hit $100.
Ben also plans to buy 100 shares of GOOG 0.00%↑ at $100. However, instead of placing a Limit Order at $100, he sells a Put Contract at $100 Strike. As soon as he sells this put contract, he receives extra cash from the brokerage for taking on the risk of the stock falling below $100.
1 month passed, and the GOOG 0.00%↑ dropped to $90.
Aaron’s Limit Order got triggered and he bought 100 shares at $100.
Ben’s Put Contract got exercised and he has to buy 100 shares at $100.
Both of them ended up buying 100 shares at $100. However, remember that Ben received extra cash from the brokerage for waiting?
Ben is smart. Be like Ben.
Note
Only use this strategy on HIGH CONVICTION stocks that YOU WOULDN’T MIND OWNING and at the STRIKE PRICE YOU DON’T MIND PAYING for the stock.
Contracts that expire in 30 days or less has the highest Time-Decay value.
i.e. You get the most money out of your time waiting.
To gain a higher premium, try to sell the option when volatility is high. You can use the “IV Percentile” data provided in your brokerage platform as reference.
It ranges from 0% to 100% , where 100% is the most volatile. Try to go for 60% and above.
Downside
1. The stock may take off while you are still waiting for the contract to expire to be assigned the shares, causing you to miss the upside.
For example, you want to buy Google at $115. On 1 Aug 2022, you sold a put contract which contract expires on 31 Aug 2022. While waiting for the contract to expire, the price dropped to $110 but went back up to $150 on 31 Aug 2022. While you may earn the cash premium from selling the put contract, you would have missed the move from $110 to $150.
2. If the stock drops way below the strike price, you will feel like you missed out on the chance to buy lower. However, you must remember that before the price went lower, you were already going to buy the stock at that price, so the result would be the same whether you used this strategy or not.
On that note, if you think that the stock will likely go lower, you can always close your position before the stock drops below the strike price. To do that, simply buy the same put @ the same strike & expiry date.
3. An option contract requires you to buy/sell 100 shares when exercised. Meaning, you cannot do this strategy if you are only planning to buy 30, 50, or 70 shares etc. It must be in multiples of 100.
Wrap up
This strategy is one of the smartest strategy I’ve ever learnt and I use it as a form of side income. The legend, Warren Buffet, also uses this method. It is normal to feel uncomfortable executing it at first because options has a lot of moving parts. However, once you dip your feet into it, you’ll wonder why you didn’t learn this earlier. Good luck!