Selling puts and calls strategy. Selling options against stocks that you own, or want to own, is a proven method for enhancing stock returns and reducing risk. The strategy is so simple that most brokerage firms allow people who have never traded options to start with that very approach. You can think about selling puts and calls as.

Selling puts and calls strategy

Selling Put Options in Smaller Trading Accounts

Selling puts and calls strategy. If you want to trade options but are short on strategies, we can help. traders can learn how to take advantage of the flexibility and full power of options as a trading vehicle. With this in mind, we've put together this slide show, which we hope will shorten the learning curve and point you in the right direction. 1. Covered Call.

Selling puts and calls strategy

However, many investors regard the sale of puts as a conservative, income generating strategy. To them, selling a put is like getting paid to issue a limit order. This article discusses the nature of the risks involved, then goes on to present some thoughts on quantifying them. Please bear in mind that I'm an individual investor talking shop, not a guru giving advice. However, it's important to understand how puts can behave in practice before selling them.

There's also a distinction between risk from an individual company's financial performance and risk from the action of the market as a whole.

Excessive exposure created by selling naked puts can create problems in the event of a serious market crisis. These risks arise from the maintenance requirements of a margin account, due to the exposure to margin calls during market crises. Here's a snip from a Margin Handbook click to enlarge images:. While initial maintenance requirements may be low, if the position moves against the investor they will be increased, creating the potential for margin calls. During the financial crisis I had a number of stocks where this happened, and experienced inconvenience and concern in dealing with the situation.

Here's where it gets problematical. What if there is no market for the options involved? As an illustration, here's a snip of a Unitrin UTR options position from my account:. This went on for weeks. The trade was profitable, and was ultimately closed at expiration for a stunning profit on a relatively short hold. But nobody was making a market for the options, and the market values and more importantly the maintenance requirement stayed out of line until expiration.

The account had ample cash and marginable securities, so the bogus maintenance requirement was not a problem. But a similar situation, which is more likely to occur at market bottoms, could cause unnecessary financial pressure and loss, due to the conduct of the market maker, not making a market, and the brokerage, applying rules on margin. Your friendly broker is a hazard during times of market stress.

The market maker will leave the building: The liquidity providers will stash their cash on the sidelines. In computing the return on the sale of a naked put, it's a good idea to consider the amount of cash used to back it up, since the apparent return and risk will vary accordingly.

HIG , in two versions. One is fully cash secured; for the other, the investor sets aside his broker's maintenance requirement. The are also two outcomes: Note that XIRR the spreadsheet function that calculates internal rate of return for an irregular stream of payments varies depending on the amount of cash security assumed. A bad outcome on a put where the investor cannot meet his broker's maintenance requirements will generate margin calls - creating pressure to sell assets under duress at market bottoms.

Investors who sell puts need to consider the above facts and govern their actions accordingly. During periods of extreme market stress, correlations go to 1 and all stocks decline in unison. Puts are not risky when used with due caution: Selling a moderate amount of puts from an account that doesn't otherwise make use of margin or other forms of leverage wouldn't be cause for concern about margin calls.

In a case like that, the investor can sell some puts on stocks he would like to buy anyway and enjoy either a little extra income, or bargain prices on selected stocks. Certain sophisticates on Wall Street disparage the covered call strategy, along the lines of "big deal, you sold a put. The sale of covered calls is widely regarded as a low risk strategy.

The cash secured item is important. If the sale of a put is not cash secured or supported by a short position, it's a leveraged strategy and the risk needs to be evaluated in that light.

It is possible, using beta relationships and applying the math from a margin handbook, to develop hypothetical maintenance or margin requirements for a given percentage decrease in an index. The reasoning would be along these lines: Having developed a theoretical minimum share price, the maximum probable maintenance requirement can be computed. As mentioned earlier in the article, it can actually work that way at times.

Another way of thinking about risk involves margin of security. With March still fairly close, I sometimes use stock prices or valuation ratios from that period as a minimum. Projecting 5 year average EPS at 3. I have an Excel workbook that I complete for most positions, and it computes a probable minimum on this basis, a figure I can look at when considering the sale of puts.

I think margin of security type thinking is the best way to control risk when selling puts. As a value investor I frequently have an opinion on minimum values and can limit the sale of puts to situations where I regard the go to zero risk as remote. Briefly, the sale of naked puts is a leveraged strategy, conducted from within a margin account, and subjects the seller to special risks involving the interaction of margin requirements and the conduct of brokers and liquidity providers at market extremes, as well as the normal investment risk associated with the underlying.

That will be the topic of future articles. I don't have any short puts on the stocks mentioned at this time. Here's a snip from a Margin Handbook click to enlarge images: Investing Ideas , Options.

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