Harris KhanA put is a strategy traders or investors may use to generate income or buy stocks at a reduced price. When writing a put, the writer agrees to buy the underlying stock at the strike price if the contract is exercised. Writing, in this case, means selling a put contract in order to open a position.
What is a Put Write Strategy?
A Put Write is a strategy where a trader writes a Put without owning the underlying, meaning, the writer does not own the stock and is not short the stock. Writing a put means you are entering into a contract that obligates you to buy the stock at a pre-determined price, called a strike price. This is only usually done if you believe the strike price will be higher than the stock price at expiration. This is a bullish strategy.
How Does a Put Write Work?
If a trader is bullish on a given stock they will place a Put Write order by selling a PUT option against it. A Put Write order will execute at whatever is the market rate or implied volatility for that option at that moment.
The trader will collect the premium for writing the Put on the stock and if the stock goes below the strike price then the trader must buy the stock from the options buyer at the strike price.
What Are The Benefits Of a Put Write
A put write is only for investors or traders who are bullish on a stock and believes the stock price will rise or remain above the strike price prior to expiration of the put. Since the put writer only receives the premium of the put sold he or she does not need to sell the stock to fund the purchase and actually gets to keep the premium.
A put write is also a limited reward strategy, the number one determining factor for profitability. The premium received is literally the only return for the trader on the trade. The maximum profit will be the strike price minus the premium received, plus commissions.
What are the Disadvantages of a Put Write
The obvious disadvantage is if stock falls to zero or below then the trader will have to buy the stock at the strike price. If the trader cannot afford to buy the stock due to the loss on the trade then, well, that is bad. The trader also has no guarantee that the stock will rise and for this reason the strategy is not a good investment for passive investors.
When Do You Use a Put Write
A put write is used when the investor or trader is bullish on a stock and believes the stock price will be above the strike price prior to expiration of the put.
When Not to Use a Put Write
If the trader is not bullish on a stock they should not use a put write strategy.
If the trader is not willing to buy the stock if it falls below the strike price they should not use a put write strategy.
If the trader does not have the financial means to buy the stock if needed then they should not use a put write strategy.
When writing a put, sizing and risk management are just as important as when buying puts. The size of the trade is determined by the amount of capital at risk and the risk tolerance of the investor. The amount of capital at risk and risk tolerance will vary between investors. Generally, the risk in a put write strategy can be managed in one of two ways: the number of contracts or the total size of the trade. Most investors who use write strategies trade only a few contracts at one time or trade a limited amount of underlying. The maximum profit potential for a put write strategy is unlimited while the maximum risk is limited to the premium of the put sold as long as the stock is below the strike price.
What is a “Straddle” a “Strangle” and a “Straddle Write”?
A “Straddle” is a trade whereby the trader buys one call and one put with the same strike price and expiration. A “Strangle” is when the trader buys one call and one put with different strike prices and different expiration dates on the same underlying. Finally a “Straddle Write” is when the trader writes a covered call against a stock he or she owns and writes a put against the same stock.
What is a “Straddle”
A straddle is a strategy used to make a directional bet on whether a stock will move up or down. Since the position can be both a call and put, it will have unlimited potential profit if the trade goes in the right direction but unlimited risk since the stock price could move beyond the strike price of both options. The maximum profit will be equal to the premium received for selling the options. The maximum loss will be equal to the price of the stock minus the difference between the strikes (the amount of premium received), plus commissions, if the stock is below the strike price at expiration. In reality, since the strike price is the price at expiration, the max loss will occur if the stock is below the strike price at expiration and could even result in a net loss.
What is a “Strangle”
A strangle is a limited profit, unlimited risk options trade. The trader writes one call and one put at different strike prices and receives the premium for both. The profit is limited since the highest profit comes if the stock price is exactly at one of the different strike prices. The maximum profit that can be gained will be equal to the difference between strikes minus the net premium received for both puts and calls. The trade can be placed for a debit (pay to enter) or a credit (receive premium).
What is a “Straddle Write”
The Straddle Write is the combination of a “Covered Call” and a “Put Write” strategy. This strategy is used when the trader owns the underlying stock, meaning he or she is long stock and is bullish on the stock. The trader writes a call against the stock and writes a put against it with the same strike price and maturity.
This strategy is used by those who are bullish but want to generate income from their stock rather than selling the stock to generate income. This strategy is not suitable for passive investors.
In Closing
Options contracts you may purchase/trade/writes can be risky and you need to be aware of the risks involved. Options trading is not suitable for all investors since the risk of loss may be substantial. However, done correctly with risk management put in place, it can be a very good strategy.
