The textbook definition of an option is as follows: The right, but not the obligation, to buy or sell a specified asset at a predetermined price over a predetermined time.
Buying a Put
Buying a put is a bearish strategy that requires a price drop in the underlying instrument (stock or ETF). Nonetheless, the most critical factor in trading puts profitably is an ability to predict the future price moves of the underlying instrument.
The investment return on a put is the profit or loss divided by the initial investment. The formula is the following:
Return = (profit or loss)/initial investment
For example, if you buy a S&P 500 (NYSE: SPY) option for $4 and sell it for $6, for a profit of $2, your return on investment is 50% (2 divided by 4 equals 0.5, or 50 percent). Annualizing the return will give you another perspective on the return. If this particular trade covered 3 month from beginning to end, you would have made a 200 percent annualized return.
However, in most cases, the return on investment is not the major criterion of buying a put. The main reason for buying is leverage. You can gain large percentage gains with a small investment. The low price of puts makes discussions of rates of return almost meaningless when examined on a trade by trade basis. Many of your trades may make 200 percent, but your losses may be 100 percent. These are large percentages simply because the initial investment is so low.
Selling a Put
Selling a put is a bullish strategy. Put sellers want the price of the underlying stock or ETF to rise so they may buy back the put at a lower price or simply let the instrument expire worthless. The ideal situation for a put seller is for the price of the stock or ETF to move above the put’s strike price at expiration, thus rendering the put worthless. The put seller will have captured all of the premium as profit.
Here is the best way to bring in income from options on a regular basis is by selling vertical call spreads and vertical put spreads, otherwise known as credit spreads.
What is the perfect options trade? That's what I asked my colleague Andy Crowder. Turns out, Andy is about to reveal his favorite strategy and the perfect trade.
I think I have found the perfect options trade . . . at least that’s what a few subscribers told me last week. You decide. I’ll be going into more detail about this type of “perfect options trade” in a free income event I’m hosting. You can click here to attend. As you can see [...]
Put-selling is by far the best way to obtain the stock or exchange-traded fund you have been eyeing for a much lower price than where it’s currently trading. But it's not for everybody.
This week I am focusing on selling puts for income, a basic strategy that is a cornerstone of most of my trades. If you're looking for income, this is where you start.