Key Takeaways
- Selling put options can generate income and allow investors to buy stocks at desired lower prices. Proper stock selection and risk management are crucial.
- Investors earn premiums when selling puts, which they keep if the stock stays above the strike price, creating a situation similar to a limit order.
- Key risks include being obligated to buy shares at the strike price if they fall below that level, necessitating careful position sizing.
- This strategy requires understanding options and ensuring financial readiness to purchase the underlying shares if assigned.
- This approach is primarily a stock acquisition method, with premium collection as a secondary benefit.
Selling put options is an options trading strategy where an investor agrees to buy a stock at a specified price before a set expiration date, in exchange for collecting an upfront premium. This approach is often used to generate income or to potentially acquire shares at a lower cost, making it appealing to income-focused and value investors. By knowing how the strategy works, its advantages, and the risks involved, you’ll understand whether selling puts fits your trading goals and risk tolerance.
Understanding Call and Put Options
Options give investors different ways to profit from market movements without directly buying or selling stocks. These financial tools come in two main varieties: calls and puts.
Call options act like a down payment on future stock purchases. When you buy a call, you gain the right but not the obligation to buy shares at a set price (called the strike price) within a specific time frame. You’re essentially reserving the right to buy shares at today’s prices, even if they go up tomorrow.
Puts work in reverse. Buying a put gives you the right to sell shares at a guaranteed price—effectively an insurance policy against falling prices. When you sell a put option, you’re essentially playing the role of the insurance company—collecting premiums in exchange for agreeing to buy shares at a specific price if they fall.
If you’re new to options trading, this list will help you keep this straight:
- Buying a call: You have the right to buy a security at a preset price.
- Selling a call: You must deliver the security at a preset price to the option buyer if they exercise the option.
- Buying a put: You have the right to sell a security at a preset price.
- Selling a put: You must buy the security at a preset price from the option buyer if they exercise the option.
Effective Strategies for Selling Put Options
The strategy’s main benefit—generating income by collecting premiums—only works if certain rules are followed. You’re essentially functioning acting as an insurance company, so do what they do: carefully select which risks you’re willing to take on and keep adequate reserves for potential claims.
The first rule of selling or writing puts is that you should only do so for stocks you genuinely want to own. Think of it as placing a limit order to buy shares—because that’s effectively what you’re doing. If you wouldn’t be comfortable buying 100 shares of Tesla at $200, don’t sell puts at that strike price.
Tip
The best put-selling candidates are stocks you’d be happy to own at a discount to current prices.
The second critical rule involves pricing. Calculate your “net price”—that’s the strike price minus the premium you collect—before entering any trade. For example, if you sell a $150 put on Advanced Micro Devices Inc (AMD) and collect $3 in premium, your net purchase price would be $147 per share if the stock falls below $150. This net price should represent a good value for the stock.
Position sizing is another crucial consideration. Experienced put sellers tend to limit their exposure to 15% to 20% of the cash needed to buy shares. Each put contract represents 100 shares, so a $150 strike price would require $15,000 in cash or margin if exercised. Your broker may require you to have all of that in your account to cover your potential obligation.
Important
Your broker can force you to sell other holdings to cover your position if you don’t have available cash in your account.
Practical Examples of Put Selling
Let’s walk through an example. You’ve been watching Company ABC, whose stock currently trades at $100. After analyzing the company’s fundamentals and technical support levels, you think it’s unlikely to drop below $95 in the next month. Instead of placing a limit order to buy at $95, you could sell a put option.
Here’s how the trade would work: You sell one put option contract with a $95 strike price expiring in one month, collecting a $3 premium per share. Since each contract represents 100 shares, you receive $300 upfront ($3 × 100 shares). This premium is yours to keep, no matter what happens to the stock.
Your broker will require you to maintain either $9,500 in cash or adequate margin capacity to cover your potential obligation to buy the shares. Make sure you understand your broker’s requirements before entering the trade.
There are two possible outcomes:
- ABC stays above $95: The option expires worthless, and you keep the entire $300 premium, representing a 3.2% return on the $9,500 in cash or margin required to secure the put ($95 × 100 shares).
- ABC falls below $95: You’ll be obligated to buy 100 shares at $95 each, or $9,500 total. However, your actual cost basis would be $92 per share ($95 strike price – $3 premium), representing an 8% discount from the $100 price when you entered the trade.
Assessing Worst-Case Scenarios in Put Selling
Let’s look at another scenario to see what happens should things go completely in the wrong direction for you. Keep in mind that the maximum loss possible when selling or writing a put is equal to the strike price minus the premium received.
Suppose Company XYZ’s stock is trading for $50, and you sell three-month puts with a strike price of $40 for a premium of $5. Let’s say you sold 10 put contracts, and you collect $5,000 in options premium ($5 × 100 shares × 10 contracts) since each put contract covers 100 shares.
Later, the front page of Investopedia reports that federal regulators and law enforcement are investigating Company XYZ for having engaged in massive fraud, which results in the company being quickly forced into bankruptcy just before the options expire. The shares lose all value and are trading near zero.
The put buyer will exercise the option to “put” or sell the shares of Company XYZ at the strike price of $40, so you’re forced to buy these worthless shares at $40 each for a total of $40,000. There is some consolation: your net loss is $35,000 ($40,000 less $5,000) because you collected $5,000 in option premium upfront.
Tip
In rising markets, it’s often best to focus on selling puts on high-quality stocks during brief market pullbacks rather than chasing higher premiums from writing options on less predictable companies.
Navigating Put Selling Across Market Conditions
The beauty of put selling lies in its adaptability to various market environments—if you adjust your strategy accordingly:
Put Selling Strategies in Bull Markets
During strong markets, as in 2024, put premiums tend to be lower because there’s less fear among traders. However, you can still find opportunities.
Strategy: You could consider selling puts at strikes 10% to 15% below current market prices. For example, say Microsoft Corporation (MSFT) is trading at $400, you might sell puts at $350, collecting smaller premiums but with less likelihood of shares dropping to your strike price. The key is to be more selective and patient, focusing on temporary pullbacks in strong stocks.
Tip
The best put-selling prospects tend to arise when investors are at their most anxious, but that’s also when careful position sizing is most important.
Put Selling Tactics During Bear Markets
Bear markets, like when the S&P 500 index dropped 19% in 2022, can offer the juiciest put premiums since nerves are jittery on Wall Street.
Strategy: However, this is when position sizing becomes critical. Instead of selling puts at just one price level, consider “laddering” your strikes. For instance, if you like a $50 stock, you might sell one put at $45, another at $40, and another at $35. This way, if the stock continues falling, you’re buying shares at progressively lower prices while collecting bigger premiums.
Optimizing Put Selling in Sideways Markets
Markets that move sideways (trading within a consistent price range) can be ideal for put selling. During these periods, you should work to identify clear support levels—prices where stocks have previously stopped falling before bouncing higher.
Strategy: If a stock has repeatedly bounced off $80, selling puts at that level could make sense. The premiums won’t be as high as in bear markets, but the probability of success could be higher if price patterns are well established.
Why Would an Investor Write a Put?
The two main reasons to write a put are to earn premium income and to buy a desired stock at a price below the current market price.
Is It Better to Buy a Call or Write a Put?
Investors with lower risk tolerance might prefer buying calls. More savvy traders with high risk tolerance may prefer to write puts. Buying a call is a simple strategy with your maximum loss limited to the call premium paid and your maximum gain is theoretically unlimited. Writing a put limits your maximum gain to the put premium received. Your maximum loss is much higher and is equal to the put strike price less the premium received.
Is It Advisable to Write Puts in Volatile Markets?
Volatility is one of the main determinants of option price so write puts with caution in volatile markets. You might receive higher premiums because of greater volatility but your put may increase in price if volatility continues to trend higher. You’ll incur a loss if you want to close out the position.
Writing puts in such a market environment may still be a viable strategy if you think the volatility increase will be temporary and you expect it to trend lower.
The Bottom Line
Put selling offers investors a strategic way to collect income while potentially buying stocks at below-market prices. When done right, this strategy lets you get paid while waiting to buy shares at your desired price point.
However, success requires more than just chasing the highest premium—you must be financially and mentally prepared to take ownership of shares if they fall below your strike price. Remember that collecting, say, a 3% premium might seem attractive, but it won’t offset significant losses if you’re forced to buy a stock that’s in free fall. The key is to treat put selling primarily as a stock acquisition strategy with collecting premiums as a side benefit.