Get Paid to Wait: An Introduction to Selling Put Options

Have you ever wanted to buy a stock but wished you could get it at a lower price? What if I told you there's a way to get paid while you wait for the price to drop? Yes, you heard that right—you can actually earn money by doing nothing but waiting. It sounds too good to be true, right? That’s exactly what I thought until a mentor of mine, a seasoned options trader, introduced me to this strategy. Since then, I’ve come to understand that investors of all sizes—from individual traders to massive hedge funds—use this technique daily to generate income without having to lift a finger.

In this blog post, I’m going to walk you through the basics of this strategy, known as selling put options, and explain how it can be a win-win for anyone looking to invest in the stock market. We’ll break down the concepts in simple terms, using relatable analogies, and discuss the potential outcomes and risks involved.

The Basics of Put Options: A Simple Explanation

Before we dive into the strategy, let’s first understand what a put option is. At its core, a put option is a financial contract that gives the owner the right to sell a stock at a specific price (known as the strike price) within a certain timeframe. After this period expires, the option is no longer valid.

If this sounds confusing, don’t worry—let’s break it down using a relatable analogy.

Think of It Like Insurance for Your House

Imagine you own a house valued at $300,000 at the beginning of 2007, right before the housing bubble burst. You’re worried that the value of your house might plummet, and you want to protect yourself from significant losses. So, you decide to buy an insurance policy that guarantees you can sell your house for $275,000 anytime before April 1st, 2007. If the housing market crashes and your house’s value drops to $200,000, the insurance company steps in and buys your house for $275,000, protecting you from further loss.

This insurance policy is similar to a put option. The strike price in this scenario is $275,000—the price at which you can sell your house. If the market crashes, you’re protected up to that strike price.

Now, let’s take this concept and apply it to the stock market.

How Selling Put Options Works

When you sell a put option, you’re essentially offering insurance to someone who owns a stock. You’re saying, "If the stock price drops to a certain level (the strike price), I’ll buy it from you at that price." In return for making this promise, you receive a premium—a fee paid by the buyer of the option.

Here’s where the strategy becomes powerful: if the stock price never drops to the strike price, you get to keep the premium and can sell another put option, earning more income. If the stock price does drop, you end up buying the stock at a price you were happy with in the first place, and you still keep the premium.

Let’s walk through a real-world example to make this clearer.

Real-World Example: Selling a Put Option on Apple Stock

As of today, Apple’s stock price is around $210 per share. You’ve always wanted to add Apple to your long-term portfolio, but you’d prefer to buy it at a lower price—let’s say $189. Instead of waiting and hoping the price drops, you can take action by selling a put option.

Here’s what you could do:

• Sell a put option with a strike price of $189 and an expiration date 30 days from now.
• Let’s assume the premium for this option is $5 per share.

By selling one put option contract (which covers 100 shares), you’d receive $500 ($5 x 100 shares). This money is yours to keep, no matter what happens.

Now, there are two possible outcomes:

1. The Stock Price Stays Above $189: If Apple’s stock price remains above $189 until the option expires, you have no obligation to do anything. You simply keep the $500 premium and can sell another put option, generating more income.
2. The Stock Price Falls Below $189: If Apple’s stock price drops to, say, $185, you’ll be obligated to buy 100 shares at $189 each. But remember, this was your plan all along—you wanted to buy Apple at $189. Plus, you still keep the $500 premium, effectively lowering your purchase price to $184 per share ($189 strike price - $5 premium). That’s another win.

The Pros and Cons of Selling Put Options

Like any investment strategy, selling put options has its advantages and potential drawbacks. Let’s explore both to give you a balanced view.

Pros of Selling Put Options:

1. Income Generation: One of the biggest benefits of selling put options is the potential for steady income. Each time you sell a put option, you receive a premium. Over time, these premiums can add up, providing a nice stream of income, whether you’re retired or juggling a full-time job and other commitments.
2. Lowering Your Cost Basis: If the put option gets exercised (meaning the stock price falls below the strike price), you’re not just buying the stock you wanted at the price you were willing to pay—you’re effectively buying it at a discount, thanks to the premium you received. This lowers your overall cost basis for the stock.
3. Flexibility: Selling put options gives you the flexibility to choose different strike prices and expiration dates based on your market outlook and investment goals. You can tailor the strategy to fit your risk tolerance and financial objectives.
4. Minimal Monitoring Required: This strategy is perfect for those of us who work full-time and don’t have the time to monitor the market every minute of the day. Once you initiate the trade, your brokerage will handle the details, and you already know the possible outcomes. This reduces trading anxiety and lets you focus on your other commitments.

Cons of Selling Put Options:

1. Obligation to Buy: One of the cons of this strategy is the obligation to buy the stock if its price falls below the strike price. If the market takes a significant downturn, you could end up buying the stock at a much higher price than its current market value. For example, if Apple falls to $170 or $150 per share, you’re still obligated to buy it at $189. However, if you’re already committed to owning this stock long-term, this may not be a dealbreaker.
2. Limited Upside: The income from selling put options is capped at the premium you receive. Unlike owning the stock outright, you don’t benefit from any major upside profit if the stock price rises significantly. For instance, if Apple’s price jumps to $250, your gains are still limited to the premium.
3. Risk Management: This strategy requires careful risk management. You need to be comfortable with the possibility of owning the stock at the strike price, even if the market drops further. It’s crucial to choose strike prices for stocks you genuinely want to hold long-term.

Key Considerations Before Selling Put Options

If you’re interested in using this strategy, here are some key points to consider:

1. Choose Quality Stocks: Focus on selling put options on stocks you genuinely want to own and are willing to hold for the long term. Avoid volatile stocks or meme stocks like GameStop, which may not be suitable for this strategy.
2. Have the Funds Ready: Most brokerages require you to have the funds available to buy 100 shares of the stock if the option is exercised. This is often referred to as a “cash-secured put.” Make sure you have enough cash in your account to cover the purchase if it comes to that.
3. Avoid Overleveraging: Some brokerages might allow you to sell put options without having the full funds available, using a credit line instead. This is known as selling “naked” options. However, this can be risky, as you might end up paying interest on the borrowed funds. It’s generally safer to stick to cash-secured puts to avoid getting into a difficult financial situation.

Conclusion: Is Selling Put Options Right for You?

Selling put options can be a powerful strategy for generating income while waiting for the right stock price. It’s a win-win scenario if you’re strategic about it: you either earn income from the premiums or buy a stock you wanted at a discount.

However, like all investment strategies, it’s important to understand the risks involved and to make informed decisions. If you’re new to options trading, start small, and take the time to learn and understand how these strategies work.

In an upcoming video, I’ll be diving into more details about how to determine strike prices and other factors that influence the premiums you receive from selling put options. Stay tuned for that!

If you found this blog post helpful, I encourage you to watch the embedded video for a more detailed explanation and visual examples. Don’t forget to subscribe to The Joyful Trader for more tips and strategies about options trading and investing.

Trade wisely, live fully, and I’ll see you in the next post!

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