The setup
- Sell a put, strike price A
- Generally, the stock price will be above strike A
The strategy
Selling the put obligates you to buy stock at strike price A if the option is assigned.
When selling puts with no intention of buying the stock, you want the puts you sell to expire worthless. This strategy has a low profit potential if the stock remains above strike A at expiration, but substantial potential risk if the stock goes down. The reason some traders run this strategy is that there is a high probability for success when selling very out-of-the-money puts. If the market moves against you, then you must have a stop-loss plan in place. Keep a watchful eye on this strategy as it unfolds.
Options guys tips
You may wish to consider ensuring that strike A is around one standard deviation out-of-the-money at initiation. That will increase your probability of success. However, the lower the strike price, the lower the premium received from this strategy.
Some investors may wish to run this strategy using index options rather than options on individual stocks. That’s because historically, indexes have not been as volatile as individual stocks. Fluctuations in an index’s component stock prices tend to cancel one another out, lessening the volatility of the index as a whole.
NOTE: Graph details and assumptions…
The animated line depicts the profit and loss of the strategy with 24 days to expiry and attempts to display how it changes as the expiration date approaches. This line is theoretical in nature and may not represent real market conditions.
