When you are looking to get a better selling price for stock you own or you want to generate income, you write covered calls. On the flip side, when you are looking for a better buying price for stock you want to own or you want to generate some income, you write put options. The major difference between the two options trading strategies is that you don’t need to own the underlying stock before writing puts.
The trade command is ‘sell to open’. You get paid the option premium after placing the trade. After that, you wait and watch till the expiration date. If the price of the stock drops, you get to buy your stock at the strike price (and keep the premium). What if it doesn’t drop? You get to keep the premium anyways and can write more puts if you want.
Wondering when to write puts? There are two main scenarios when you write puts:
1 – You believe that the stock will increase in price or hold steady. In this case you will get to pocket the premium and you have the chance to write more puts.
2 – You want to own the stock even if the price declines and you arent expecting it to take off anytime soon.
There are a few risks you should bear in mind before writing puts:
1- Your stock could increase significantly while you are waiting to exercise your puts.
An example: Lets say you wanted Apple stock (AAPL) at around $105. Its trading at $120 currently. You think its an ok buy at $120 but you think its a much better buy at $105. In your estimates, its fairly valued at $140. So, you write some put options for the $105 strike price. In between Apples quarterly earnings come out.
They just blew past the analyst estimates and the stock is now at $150. In this scenario, you chose to buy a volatile stock like Apple at a lower price but it zoomed past your fair value estimate and you could do nothing but watch. In situations where you think that the stock could large move upwards at any point and you are not willing to miss out any gains you should buy the stock outright rather than writing puts.
2- Your stock drops to your strike price and you get to exercise your option. But, it continues to decline after you buy it.
An example: You think that Microsoft (MSFT) is a buy at $30. Its currently at $35 and you write puts for $30. Around the expiration MSFT makes a downward move and you get to buy the stock at the price you wanted. But in the few months you hold it MSFT continues its downward move to $24.
In this case, you got a better buy price than you would’ve if you had just bought the stock outright but you are still holding shares of stock that are depreciating. At this point, you have decide whether you think MSFT is worth holding longer term if the decline continues.
Article Source: Articles Engine
Since you are familiar with call and put options examples, are you ready for more advanced options trading strategies? Visit http://www.e-options.org/ to take your options trading knowledge to the next level.