Selling Puts???

Selling puts is an *extremely* inadvisable strategy!! Why? simply look at the nature of the trade.

You are looking at a predefined profit (the premium you receive) and are open to unlimited risk!!

As a trader I'm sure that you would agree that the exact opposite is the ideal....

that is unlimited profit potential....with limited risk.

Wow!! can't believe that somone would advise that in a book just like that (snap)!!

It is possible that the first few trades are winners and lull the trader into believing that there this is easy, just like writing yourself a check. That's exactly when the market will wake you up to the cold reality.

I'm not fanatical and realize that shorting/writing puts has its place in a well thought out trading arsenal. However it is NOT to be used by a novice!! An expert trader will always consider the greeks when thinking about selling puts as well as many other considerations.



 
First off, selling puts is NOT "unlimited" risk. This is a common misconception. A stock can only go to zero. So there is a clearly defined maximum risk in such a trade. It may be more than you want to assume in the event of catastrophe, but it is not unlimited. Selling calls is another story, because there's no theoretical limit to how high the stock price can go.

Second, selling puts is IDENTICAL to buying stock and selling covered calls. However, for some reason people believe that's less risky.

Third, unwinding or protecting a short put is easier than with a covered call. For instance, if the stock price is dropping to the strike you sold or to your cut and run level, you can short the stock and create a covered short position which offsets your liability in the short put. If the stock heads back higher you can cover the short stock.

Fourth, some people simply use short puts as better margin surrogates to buying the stock (whether for investment, position trades, or medium term swing trades) by selling ATM/ITM puts with high premiums on stocks they would otherwise be prepared to own for the resulting net cost basis. General liability isn't really any worse than owning the stock (in fact depending on the transaction, specific liability is often better than buying the stock outright) and you can still use similar position management techniques to manage risk.

Finally, sure it would be great to have unlimited profit potential and limited risk. It would also be nice to be able to eat a gallon of Cherry Garcia and not gain any weight. In practice it's not that simple due to time decay, volatility collapse, etc.

In fact, there's nothing wrong with a well crafted limited profit potential and limited risk position. You can sell credit put spreads (or credit call spreads if you're bearish) to create such positions. They're not as open ended as a naked short put but you also give up some of the profit potential in exchange for the smaller maximum risk.

There are many longer term opportunities to do this which have the potential to deliver excellent ROI with fixed risk even with little or no upward movement in the stock price. Such credit spreads will also usually outperform straight call/put buying except in the rare case of a very quick and/or very large stock price movement.

Selling premium is not an extremely inadvisable strategy. It is, like any trading strategy, inadvisable only if you don't understand it completely.
 
AA-totally agree with your points. Perhaps I got a little too evangelical! My feeling is that put writing should not be the first option transaction that a person engages in.(It seems to me that the person who started this thread was new to options) Although it is exactly the same in profile as a covered call, to the person writing it may not seem so, causing them to hold on as the stock falls.

As I mentioned in my last paragraph I think that a forgotten point (by many novices) is the volatility of an option. By selling a cheap put that increases in volatility it is possible to just break even or to perhaps lose money - even though the stock has potentially moved in your favour.
 
In my thread at ElectronicDaytrader.com, a comment was made
about covered call writing , which is mathematically the same as naked put selling and I have included my reply below:

Be aware that Covered Call writing is mathematically the same as naked put selling. Selling puts is a good strategy
if it is done selectively. I like to do
covered writing or put selling in LEAPS
(long term equity options) , when the option
volatility is high. I will give you an example of a covered write with one month to
go until expiration:

Long 100 Shares of XYZ and Short -1 65 Call

assume yearly stock volatility 41.50%
interest rate 5.75%
dividend yield 0%


I could sell the 65 calls for 3 1/4. What should the 65 puts trade for?

Answer: Approx 3.00 Why?

Stock 65 + 65 put 3.0= 68


65 strike & Call Price= 68 1/4

Why is there a 1/4 difference between the
Stock + Put=68 and 65 Strike & Call 3 1/4 =
68 1/4? The 1/4 dollar represents the cost
of carry for the stock for approx. one month at 5.75% interest(for one month).

Is it better to sell the 65 puts or do
a covered write with the 65 calls?


Answer: You do the strategy that gives you more option premium since selling naked puts is the same as covered call writing.If I could sell the naked 65 puts for the same price as the calls (3.25), I would make more
in my account since I would not have to pay any margin interest.

I have attached Dr. Robert Lums Option Calculator to my site at http://www.electronicdaytrader.com/tools.htm
Click on "Robert's Online Option Pricer". I also have free option analytics that load into MS excel(free).Try different option scenarios using the analytics on my site to see how different option strategies are priced in the market . I welcome any comments from traders.
Be aware that there is no "layup" strategy that will work
well in options all the time. Like stock trading , you must
adjust your option trading strategies based on market
conditions, stock volatility , option volatility and trading
capital.


Gene Weissman
Managing Member
ElectronicDayTrader.com
Lieber & Weissman Sec.,L.L.C.
gweissman@stocktrade.net

See my site at http://www.electronicdaytrader.com

This example is only for comparison purposes.
Options involve risk and are not suitable for all investors Prior to buying or selling an option, a person must receive a copy of Characteristics and Risks of Standardized Options. Copies of this document are available from your broker or the Chicago Board Options Exchange, 400 S. LaSalle Street, Chicago, IL 60605.


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