A put option is a contract you can buy or sell on a stock. 1 contract controls 100 shares of a stock.
A put option if bought gives you the right to ‘put’ the stock to someone at the strike price.
A put option if sold – is selling someone else the right to ‘put’ the stock to you at the strike price.
Selling a put option is setting a ‘floor’ for a stock.
Buying a put option is setting a ‘ceiling’ for a stock.
Example: an example of selling a put option.
Stock A is currently priced at $35, you think the stock will stay at $35 or maybe go higher. The idea would be to set a floor by selling a PUT option.
If you thought the stock price would go below $35 you could buy a PUT option.
Since a option contract controls 100 shares; selling something like $34 put option would require $3,400 in buying power minus the premium you collected. That is a lot of money for a smaller account. Remember you would sell a put option if you think the price is going to stay the same or go up.
If you bought the $34 put option instead; you would hope the price falls below $34. However instead of tying up $3,400 – you only risk whatever you bought the option for.
You might read the above and think you’d rather buy options instead of sell them. However it’s the exact opposite. When you buy an option you have one direction – the stock has to move. When you sell an option you can profit with the stock not moving at all or moving in the direction your position requires.
This is because of Theta or the effect of time on the option position. Simply all options have expiration dates and as this date nears the price of the stock more closely relates to the option value. When buying a option the time works against you – when selling an option the time works for you.
When you combine the ideas that time works for you and you have 2 ways to win (price staying the same or moving in your favor) vs only winning if the price moves correctly and time working against you – selling premium is the way to go.
Good news: Options have many ways to trade – and one of my favorites is an Option Vertical Spread. An option vertical spread is where you can sell one option then buy another of the same expiration. The premium is the difference between the 2 strike prices. You can buy or sell this difference. Learn more about verticals.