Today, we’re going to talk about the option and what we’re going to do and discuss is talk about selling put option contracts.
Selling put is similar to looking for upside in a specific stock. It is a little bit different when you’re dealing with selling option contracts rather than buying options contracts. Yes, you can sell options contracts. It’s not that you have to buy a put or buy a call.
Some people don’t understand that you can be a seller of options, just like people at a dealership will sell you a car before it’s even on the lot. The same thing here with option contracts, you can sell them also if you don’t have them. You’re selling these contracts to other people that are interested in buying them.
The issue is, of course, you will have to deliver what you promised based on the contract, and I’ll show you what that looks like in the risk profiles and pictures which will make a lot more sense as we go through the lesson.
What is a put option contract?
In general, when you’re buying a put contract or buying a put option, it means that you’re looking for the stock to go down. In other words, you have a bearish outlook.
That’s what happens when you’re buying a put contract now.
When we’re selling a put option, what this usually means if you’re looking for the stock actually to go up. You’re bullish. And that’s what we’re going to be discussing right now. We’re going to be looking at the sell side of the put option contract.
It’s a little more confusing for some people. Just understand that there are four parts to a trade:
- you can be a buyer of a put
- you can be a seller of a put
- you can be a buyer of a call
- you can be a seller of a call
So there are those four parts to trading an option contract. You can be on any one of those sides when you’re trading options.
If you want a quick little cheat sheet, here’s the way you want to look at
If you’re a buyer of a call, you want things to go up. A buyer of a put, the same thing, if you have the basics down, you’re looking for that price actually to go down in the stock.
If you’re a seller, it works opposite. If you’re a seller of a call, you want prices to go down because if you’re a buyer, you want prices to go up. So being a seller, you wish to the opposite of what the buyer wants.
The seller of a put is the same thing. It’s opposite to the buyer of the put. So, if you’re a seller of a put, you want the prices to go up.
Long story short, these are the combinations that you have available. There’s your quick reference guide.
Let’s take a look at the risk profile picture
We have our primary zero line here on the chart, and anything above that zero line is profit. Anything below that zero line is a loss. So profit and loss are dictated here on the left.
Now on the bottom, these numbers are the stock prices. As a stock price head tire, you can see what happens to the graph. Our profit stays the same when we sell a put. We have a max profit that we can make right there at that exact point.
The problem with selling contracts is you have an unlimited loss. When it comes to selling a put, your unlimited loss actually can only go down a zero because the stock price can go to zero.
When it comes to options, you have two main things on the profit picture.
You have a profit picture of the line at the expiration of that contract, and then you also have a line that today with a time that line gets closer and closer to the line that expiring. So you have that decay.
The good thing about selling a put contract is this line gets closer, so you make more money as it gets closer to that expiration.
Take, for example, you are selling this put contract, and you’re over here at this price point. At the zero line, right around the $22 range.
With time, that line will get closer and closer, and at expiration, you make quite a bit of money. If that stock price goes up to let’s say $35 a share within the next 24 hours, your profit potential would be a little bit higher.
But if you can hold it up until expiration, you actually would make the most from that contract. It doesn’t matter if the stock stays above 25 and it’s 25.05, or if it’s 60 or a 150, you will make the same amount.
The issue with selling something is you’re tapping or creating a max profit potential. Whereas, if you’re buying a call or buying a put, you have more unlimited profit potential.
If you bought a put, you’re looking for unlimited profit potential as the stock goes down, up and throws a zero point.
If you’re buying a call, it’s going to look slightly different. You’re going to get a chart that looks something to this effect, but then you still want the stock to go up, but at least you have that unlimited upside potential. Whereas, when you sell a put, we make a maximum on our contracts, but when you’re buying a call, you make an unlimited amount.
The problem with buying a call over here in the top right section if you’re losing money day in and day out whereas when we’re selling this put we make money day in and day out.
Let’s take a look at selling a put option contract on a trading platform
The first thing I want to do is go ahead and buy a single call just so that way you can see what that looks like.
If we buy a single call, you can see I’m still looking for upside, but my upside potential is pretty much unlimited. It’s going to be upside my max risk – is negative, about $153, which you can tell by this little green amount in the lower left or also the amount that I’m buying that contract for that’s buying a call contract.
If we’re buying a put contract, you’re looking for that stock actually to head lower. And again you get unlimited to the downside right up until it hits zero, but the problem is we lose $2.52 every single day.
If we turn this into selling a put contract, you can see I get that upside exposure. What I want is this stock to go up to the upside or stay above at least this 145/146 level because our contract is at 145. As long as that stock stays above 145, I’m perfectly fine right now.
The issue, of course, is if this continues to move lower and lower in price, I can lose quite a bit of money because again this is a naked option contract. I’m selling something naked because I’m selling a single.
Ultimately, most traders do is they’re selling contracts similar to this, and they’re collecting the data from it, letting those contracts expire day in and day out.