Selling a put obligates you to buy shares of a stock or ETF at your chosen short strike if the put option is assigned.
For example, let’s say you wanted to buy the United States Oil Fund (NYSE: USO), but not at the current price of $47.34. You prefer to pay $42.
By selling the May 18.5 puts you can bring in approximately $0.37 or $37 per contract. In this instance, you are selling the put with the intent of buying the stock for $18.50 if, at expiration in roughly 28 days, the stock is trading at or below $18.50.
Selling the 18.5 put requires you to have $1,850 of cash in your trading account.
Typically, selling puts only require 20% of the $1,850, or $370, but retirement accounts and certain brokers require the puts to be cash-secured. And in this case, that would be the $1,850. The return on the trade is 2% over roughly 30 days….24% annually. And if the puts were not cash-secured, the return would be significantly higher.
As you can see from the options chain below, you have other levels where you can sell puts. If you choose to sell a strike closer to the current price of the stock, say $19, you could bring in even more premium, but the probability of success goes from 70.96% for the 18.5 puts to 63.31% for the $19 puts. So, you do have to make a few decisions as to how much risk you are willing to take based on the strike you choose.
Back to our example, we decided to sell the May 18.5 puts for $0.37. The $37 is ours to keep regardless of what occurs with USO.
If the stock closes at May expiration above $18.5, we keep the $37 and oftentimes repeat the process by selling more puts, maybe at the 18.5 strike or possibly at a different strike price. It truly depends on where the stock is trading at the time we sell the puts and how much premium we wish to bring in.
If the stock trades for less than $18.50 at May expiration we are assigned the stock for $1,850, 100 shares per put contract sold. Oftentimes when this occurs I will begin to sell covered calls on the stock so there is an ongoing source of income coming in. I take this approach in one of my High Yield Trader portfolios, appropriately named, The Income Cycle.
USO is actually one the positions in the Income Cycle Portfolio. Here is a recent trade alert that will help you to further understand how I trade ETFs like USO and more importantly, what each trade alerts covers. The trade is slightly different than what is mentioned above, but it is the process, not necessarily the trade, that is important.
United States Oil Fund (USO)
- Sell to Open United States Oil Fund (USO) May 18 puts for around $0.34 with the stock trading around $19.66
The put obligates you to buy 100 USO shares for $18 a share should the stock fall below that price at option expiration day in May. Selling these puts gives you about $34 in your account per option contract.
Buying 100 shares at $18 represents a potential obligation of $1,800. To put on this trade, your broker will require you to deposit “margin” – essentially, it’s a security deposit that assures the broker you can cover your potential obligation. It usually runs 20% for put sales. (In this case, 20% of $1,800 is $360.)
Here’s the math…
Sell one USO May put for $0.34, or $34 per contract.
Place 20% of the capital at risk in your option account, or $360.
Total outlay: $326 ($360 – $34)
If the markets remain unchanged and USO trades above $18 at May expiration, you won’t have to buy the stock. You keep the $34 premium (and the $360 margin). That’s a 9.4% return on capital in 30 days.
If USO trades below $18 at May expiration, you’ll still keep the $34. But you’ll have to buy USO at $18 per share. You’ll own USO at $17.66 (the $18 strike minus the $0.34-per-share premium). Here’s how that scenario works out for each option contract you sell …
Initial income from sold put premium – $34.
Purchase 100 shares of USO at $18 – $1,800.
Total outlay: $1,766 ($1,800 – $34).
The price ($17.66) is 10.2% below USO’s current market price of $19.66. This gives us very good downside protection.
More importantly, we will continue to sell puts, lowering our cost basis each time, until we are assigned the stock. Once we are assigned the stock we will begin to sell calls continuing the income cycle. Rinse and repeat.
We just started trading USO in the Income Cycle portfolio. With two trades under our belt, we have managed to bring in $0.68 worth of premium with an average return per transaction of 10.8%. We are perfectly happy with those return. Hopefully, we can keep them up going forward.
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