If you’re unfamiliar with options, click here to learn the basics and key terms/ideas you should know, then continue!
When you sell a put option on a stock, the buyer of the option has the right to sell you the stock at a set price before an expiration date. In return, you receive a premium. This premium effectively provides you with income.
Let’s say you have 5,000 dollars cash in your account and you decide to sell a put option with a strike price of 50 dollars. Remember, all option contracts are for 100 shares of stock. Let’s say that for selling this option you receive a credit of 10c/share, giving you 10$. If the stock stays above the strike price, you keep the premium and can walk away. This represents a return of 0.2%. Once you are past the expiry date, you can sell another put option and keep repeating this process for income.
Risks of sold puts
The stock price falling below the strike price is the main risk with selling put options. If this happens in our example, you can get assigned the stock at 50 dollars per share even if it is worth less than 50 dollars. Even though you paid more than the market price for the stock, it was beneficial to you compared to acquiring the stock at the original 55$ price. However, you could suffer more losses if the stock price continues to decline.
Real Example
Let’s look at a real example of Nvidia stock as of this writing. We can see the stock price is about $882, and the closer you get to the stock price, the more money you get. So, if you were to sell a put at $875, you would receive $16.35. That’s 1.8% ($16.35/$882). However, there is a higher chance for you to be assigned shares since the stock only has to drop a few dollars for that option to be at risk.
You’d make a lower return If we look at a lower strike price like $785, around 0.1% ($0.91/$882). But on the other hand, it is less likely that the stock moves down roughly $100 in a week, which means it is much less risky.
If you do this weekly, even a small return like 0.1% can add up to significant returns in a year. We hope that the information provided has been of assistance in enhancing your understanding of options. At BrokerBotics, we automate such income-generating trades and allow you to select your own stocks and set your own criteria for weekly or monthly returns. Sign up Today!
Disclaimer: This blog post is for educational purposes only and does not constitute financial advice and we are not recommending any particular stocks or strategies.