Reader Feedback: The “Put Your Money Where Your Options Are” Edition
Great Ones, we received such positive feedback to last Friday’s “Pondering Put Selling” edition of Reader Feedback … that we’re doing it again!
Also, I absolutely love reading and responding to your questions and emails … so keep ‘em coming!
Drop us a line with your burning questions on the market, investing, options … you name it, we’ve got answers! Here are the deets: GreatStuffToday@BanyanHill.com.
Now for today’s featured presentation.
Put Selling: Make It Rain, Man
Hi Great Stuff!
I have not traded options before, but I am intrigued.
When it comes to selling naked puts, what is the real risk, assuming it’s a stock I would like to own anyway, and I have the cash in my margin account to pay for the shares being put to me?
All I can think of is missing out on gains if the stock goes up, maybe not getting the “best” price if it goes down or being hosed if the stock goes to zero. The latter two scenarios can happen even with buying the stock outright, so really the only negative I see is missing the train if my prediction is wrong.
Am I missing something other than my train?
Thanks!
Greg (long-time reader, first time writer-inner)
Thanks for writing in, Greg! We have another put selling question to drop in here as well, but I just had to give you a personal “Hello!” for being a first-time writer-inner!
Real quick, though … you’re dead on with that strategy, Greg. You didn’t miss anything. But more on that in a minute…
Joseph,
Makes sense to me. If you’re one of those who still has money in the bank, this seems like it might be an opportune time to buy stuff — before the value of that cash steadily erodes from here.
The question then seems to be, how much “excess” cash is out there — meaning how [many years] can it support [an illusion of] consumer confidence?
I’ve yet to place my first option bet — despite having read about the advantages of doing so [“leverage” and “fixed losses”] that have been touted far and wide for many years now.
Even so, I was shocked to hear that selling Puts puts the seller at unlimited risk. My impression was that you sold the Put for a certain amount of cash — and if the stock price didn’t go below the strike price by expiration, the option expired and the cash went all to the plus side of the ledger.
Further, I thought that if the stock price hit or went below the strike price, it just meant that the stock was “put” to you at the strike price.
The idea, I thought, was that you only sell a put on a stock that you wouldn’t mind adding to your portfolio at this “discounted” price.
Sure, the price could go further down from the strike price, but that’s only a paper loss if you don’t sell it.
So, with reading your warning, I am certain that I am missing something as to how the potential losses of Put selling are “limitless.”
Might it be the case that if you fail to exercise the purchase of the stock at the strike price, that you remain on the hook to your broker somehow?
— Ken B.
Wow. So I have an “old school” Great One and a first-time writer-inner Great One today! And y’all want to know about put selling in a bear market, of all things.
Welp, who am I to tell you no? It’s your funeral.
Actually, I’m being more than a little overly dramatic here. See, I’ve always been a bit of a risk-taker in my investing life. And sometimes, it slips my mind that not everyone sells naked puts for fun and profit.
Fun and profit? Are you crazy?!
Yes, fun and profit. And no, I’m not crazy. My mother had me tested.
Essentially — Ken and Greg — you both have it right. The way you’re supposed to sell puts is to sell these options on stocks that you ultimately want to own.
We’re not talking selling puts on AMC or Bed Bath & Beyond — nobody wants to own those right now. Well … almost nobody. I’m looking at you, WallStreetBets.
Put Selling For Fun & Profit
Let’s say you want to own Occidental Petroleum (NYSE: OXY). You’ve heard that Warren Buffett really likes OXY, and you want to follow in his footsteps.
So you like the stock, but you don’t want to pay $71 per share to buy it. You think the market has some wiggle room in the next couple of months, and you think you can get it for a better price.
Let’s say you’re hoping to pick up OXY for $60. You could wait around, checking daily to see if OXY has hit $60 yet. Or you could place an order for OXY at $60 … and get paid for doing so!
I really like that last option!
I’ll bet you do. But before you rush out and start selling puts, you’ll need a margin account. I mean, you gotta have some cash immediately on hand so you can back that sold put.
After all, you’re saying you want to buy OXY stock, so you gotta prove you can … you know, buy OXY stock. To find out more about margin accounts, click here.
So after you have your margin account squared away, what you would do is sell an OXY November $60 put. This put closed Thursday with a bid price of $0.46, or $46 per contract. By doing so, that $46 per contract goes right into your brokerage account.
Then, if OXY falls below $60 before November options expire on Friday, November 18, you are the proud owner of some brand-new-to-you OXY shares — 100 per contract sold, to be precise.
This is where your margin account comes into play … you know, to buy the 100 shares you promised you’d buy?
The bonus to this strategy is that you got paid to buy OXY at the price you wanted. Eat your heart out, Priceline.
The other bonus is that if OXY doesn’t fall below $60 by the time your sold put expires, you still keep the $46 premium for selling the put. And you can do it all again next month! You can literally keep selling puts until you get the price you want.
Put Selling: Don’t Get Naked!
Now, there is a rather major downside to selling options. Most of you probably know that, when buying an option, your risk is limited to the cash paid at the beginning. If you pay $100 for an option contract, $100 is all you can lose.
However, when you sell an option, your risk is theoretically unlimited if you don’t already own the stock. FYI: Selling a put or call without owning the underlying stock is called “naked selling.”
For example, if you sold a November $80 call on OXY and the stock skyrocketed … you’re gonna have to pay the current market price to buy OXY shares to make good on that sold call. And there’s theoretically no limit to how high OXY stock can go.
The same is true when selling puts … though there is a kinda floor at $0.
For example, if you sold the November OXY $60 put and, for whatever reason, OXY collapses and becomes worthless, you’d still have to buy 100 shares of OXY at $60 each. That’s $6,000 per contract you’re shelling out for a worthless stock.
Clearly, losses on put selling are not “unlimited,” but they can get extremely steep if, say, you sold a put on a stock like Berkshire Hathaway (NYSE: BRK.A), which currently trades for $447,125.
Which, you know, is why you shouldn’t sell naked puts.
Wait, you used to do that? Sell naked puts?
I used to, yes. I mean, I still do on occasion, but I used to too.
That said, I only ever sell naked puts in a bull market. Never in a bear market. That’s just crazy … and as we’ve established, I’m not crazy.
So, Ken and Greg, I hope that answers any of your questions on how losses can be potentially unlimited when selling put options.
I mean, I didn’t really do much other than tell you what you already knew, but it’s nice to hear it from a guy that makes financial memes on the internet … so you’ve got that going for you, which is nice.
But I know you, Great Ones. Just one taste of the options market, and you’re ready to devour those sweet, sweet trades by the tray-full. Before you go off chasing waterfalls and options contracts … don’t go alone. Take Mike Carr with you!
See, Mike teaches options trading on Wall Street.
Wall Street types — and other aspiring traders around the world — fly to him to learn how to trade the way he does.
Why do people fly from all over the world just to learn from Mike? Because Mike isn’t your average options instructor — he’s one of the best options traders in the world.
It normally costs thousands of dollars to learn from Mike. Not anymore.
Because you can sign up for Mike’s Options Master Class online for a small fraction of the cost of his in-person class … the one that’s ignited successful trading paths for countless investors.
Sign up now for Options Master Class for a steal…
And with that, thank you Ken and Greg for writing in! Great Ones, keep the questions coming: If you ever have questions you want answered about stocks, options and the whole investing shebang … email us!
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Regards,
Joseph Hargett
Editor, Great Stuff