Writing Out Of The Money Put Options

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Writing Out Of The Money Put Options is essentially a naked put write strategy on out of the money put options. Writing Out Of The Money Put Options is, however, a very interesting option trading method that is different from executing a naked put write on In the Money Options ( ITM Options ) or At The Money Options ( ATM Options ) and therefore warrants its own page of explanation. Writing Out Of The Money Put Options leads to an interesting position where you profit if the stock goes up or remains stagnant and allows you to own your favorite stock at a lesser price if exercised. Doesn't that sound like the best of all worlds?

One should be familar with the Naked Put Write and what Out Of The Money Options are before executing this strategy.



Effects Of Writing Out Of The Money Put Options


Imagine being able to profit on your favorite stock if it goes up or stays stagnant and then if it falls in price, you get to own that favorite stock at a slightly lesser price than what others are paying for, wouldn't that be great?

This is exactly what Writing Out Of The Money Put Options allows you to do. Let's explore each effect closely :

Profit On A Rise By Writing Out Of The Money Put Options
When you sell a put option, you profit from the entire cost of the put options if the underlying stock rises past the strike price of the put options. This is a very directly way of making money off your favorite stock, isn't it?

Example : Assuming QQQQ at $44. Sell To Open 10 QQQQ Jan43Put for $0.15 per contract.
You will make the entire $150 in profit as long as QQQQ expires above $43 upon expiration.

In fact, if that favorite stock has risen in price (thereby eroding the value of the short put options to within a couple of cents), and is expected to continue rising in price, you could roll up the short put options by buying back the original put options that you sold and the writing new out of the money put options with a greater value. This way, you keep profiting as long as your favorite stock continues to rise.

Following up from the above example, if QQQQ rise to $45, the Jan43Put that you sold would probably be worth about $0.01 only. In this case, buy back the Jan43Put and then Sell To Open Jan44Put, which would be about $0.10 per contract. This is known as "rolling up".


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Profit If The Stock Stays Stagnant By Writing Out Of The Money Put Options
Because the put options that you sell in the Writing Out Of The Money Put Options strategy is "Out Of The Money", it remains in profit at expiration even if the underlying stock stays stagnant or drops slightly (but still above the strike price of the short put options).

Following up from the above example, as long as the QQQQ stays above $43, you get to keep the entire $150 that you got from selling the 10 Jan43Puts.

How about that? You get to profit even if your favorite stock falls slightly instead of rise!

Buy Your Favorite Stock At A Lesser Price By Writing Out Of The Money Put Options
Even the best stock in the world retreats a little frequently before continue its trip up, so do your favorite stock. How would you like to buy that stock at these slight retreats? While the Writing Out Of The Money Put Options strategy allows you to profit if your favorite stock rises, stays stagnant or falls slightly, it is also an excellent option strategy that allows you to automatically own your favorite stock at the best retreated price!

Following up from the above example, if QQQQ drops to $42.95 at expiration, the Jan43Put options you sold becomes In The Money and exercised, getting you the QQQQ for $43 (which is the level which you have predetermined to be a great price to buy this favorite stock).

So, wouldn't the position be in a loss of $0.05 when you buy the QQQQ at $43 when it is trading at $42.95? Not really. Remember the premium value of $0.15 that you got from selling the Jan43Put? In fact, you are effectively buying the QQQQ at $0.10 below the prevailing market price!

Following up from the above example:
Premium Earned : $0.15 = $150
Bought QQQQ : $43 = $4300
Net Price Of QQQQ Bought : $43 - $0.15 = $42.85 = $4285
Market Price Of QQQQ : $42.95 = $4295
You save : $4295 - $4285 = $10!


So, what if the underlying stock falls by a much greater amount? Well, even your favorite stocks can go into a sustained correction sometimes, right? That is where your stop loss point comes in. By setting a stop loss point to buy back the short put options at breakeven point, you can be assured against any real losses.

In fact, the Writing Out Of The Money Put Options strategy can be invaluable if you are familar with technical analysis and sell the short put options at strong support levels. If the stock drops to the support level, you get to buy it at that level for a slightly lower net price than the other traders are paying for and then be ready for a rebound!

In the below example of QQQQ, there is a clear support level at $46. Therefore, executing the Writing Out Of The Money Put Options strategy when QQQQ is trading at about $47 (Point A in the picture below) on the June$46Put options will not only allow you to profit when the QQQQ goes up or stay stagnant, it also allows you to buy in at the $46 support level and get ready for the rebound which you see in the picture.

writing out of the money put options example




What Do You Need To Execute The Writing Out Of The Money Put Options Strategy?


1. A broker that allows you to sell naked put options
2. Enough money in your account to buy your favorite stocks when the options are exercised

OppiE's Note Please note that every option contract represents 100 shares of the underlying stock. So, if you sell 1 put option, you need to have enough money to buy 100 shares.






Risk / Reward of Writing Out Of The Money Put Options:


Upside Maximum Profit: Limited
Limited to net credit recieved.

Maximum Loss: Limited
Limited to strike price less premium gained.

OppiE's Note Because you can lose an unlimited amount of money as long as the underlying stock continues to rise, you should always place a reasonable stop loss when executing the Writing Out Of The Money Put Options strategy at a point slightly below the breakeven point.



BreakEven Point of Writing Out Of The Money Put Options:


The breakeven point for a Writing Out Of The Money Put Options is the point below which the underlying stock can drop before the position starts to go into a loss. This is calculated as:
Breakeven = strike price of out of the money puts sold - Cost of out of the money puts sold

Following up from the above example:
QQQQ is trading at $44 and sold QQQQ's Jan43Put at $0.15. Thus the breakeven point would be $43 - $0.15 = $42.85. QQQQ needs to drop above $42.85 before the position starts making a loss. That will be a good place to set a stop loss.



Advantages Of Writing Out Of The Money Put Options:


:: Enables you to profit if the underlying stock goes up or remains flat or drops slightly.

:: Allows you to buy your favorite stock at a slightly better net price when exercised.



Disadvantages Of Writing Out Of The Money Put Options:


:: Need to maintain enough money to take delivery of the stocks when exercised.



Alternate Actions for Writing Out Of The Money Put Options Before Expiration :


1. If the underlying stock has rallied and is expected to rally further, you could continue to roll up the put optoins or to even start selling At The Money put options instead.



Writing Out of the Money Put Options Questions


:: Is Writing Put Options Speculating or Hedging?


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