EC Options Trading Part I – NFW Edition

This is a highly speculative trade, not an investment, so run away, retail investor!

options just ahead

A friend in the finance-writing space sent me a query not long ago about the idea of “selling puts” as an appropriate and lucrative investment activity.

Following my swift reply of “NFW,” she asked for an explanation. After all, a friend of hers had been writing a regular ‘investment newsletter’ describing all the clever money he made writing puts on stocks.  The newsletter-writer described a ‘win-win,’ in which either the put seller pockets the option-premium, or manages to purchase stocks at a discount to current prices.

Selling puts, I should explain, involves giving your counterpart the option, for a limited amount of time (between one and three months, typically) of selling you shares at a set price. A ‘put seller’ often picks a price lower than current prices.

For giving someone else this option, the put-seller pockets some money, known as the option premium.

How about an example?

XYZ stock sells for $50 in the market today.

I sell 3-month puts, let’s say 1,000 of them, with a ‘strike price’ at $40. That gives the put-buyer the right to sell me up to 1,000 shares of XYZ at $40 anytime for the next 3 months. For that privilege the put-buyer pays me – I’ll make this number up – $3 per put. In this example, I pocket $3,000 in premium ($3 x 1,000 puts).

In my most optimistic moments, I can tell myself that I ‘win’ if I just pocket $3,000, and I also ‘win’ if the shares of XYZ drop and I end up buying up to 1,000 shares at a 20% discount to the current market price.

Run away

However, I’m here to tell you to run, not walk, away from put selling. Do not try this at home, for a few reasons.

I’ll list them in increasing order of importance.

First, options trading for non-institutional investors (you and me) are always speculative trades, not investments, because they are short-term in nature. “Investing” means that your time horizon spans more than 5 years, disqualifying all but the most exotic options, none of which are available to you and me.

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Bankers Anonymous 7 years ago Author's comment
You're welcome. Part 2 up here. http://www.bankers-anonymous.com/blog/options-trading-part-ii-the-currency-of-options/ Part 3 up in another day or two.
Ilene Carrie 7 years ago Contributor's comment
Thank you Michael!