Definition of Selling Puts
"Selling puts" comes from the options trading arena. Puts and calls are options contracts that trade against securities like stocks, exchange traded funds and futures contracts. Options trading includes both the buying and selling of contracts. A trader who sells put option contracts is trying to accomplish a specific trading goal.
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Function
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A put option is the right to sell an underlying security at a set price for a specific period of time. Put option contracts are defined by the price at which they can be exercised (also called the strike price), the expiration date and the underlying security the contract is written against. A put buyer has the right to sell the underlying security at the strike price to the put seller at any time up until the expiration date. A buyer or holder of a put option is said to be "long the option." A put seller receives the premium for the contract and must buy the underlying security at the strike price if the contract holder elects to exercise the contract. The put seller is said to be "short the put option."
Identification
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A trader buys put options in anticipation that the underlying security will decline in value. As the underlying stock falls below the put strike price, the put option starts to increase in value. Buying put contracts is a low-cost strategy to profit from falling security prices. The put seller receives a premium for selling the put option contracts. As long as the underlying security price stays above the contract strike price, the put seller has no loss and can keep the amount of premium received for the contract.
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Effects
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Consider Apple Inc., symbol AAPL, which is selling for $246 per share. The put option with a strike price of $240 that expires in the next month has a price of $12.80. Each put contract is for 100 shares of the underlying stock, so the put seller would receive $1,280 for each contract sold. If AAPL stays above the $240 strike price until the expiration date, the put seller will get to keep the $1,280 premium received for selling the put. If AAPL drops below $240, the put seller may be obligated to buy 100 shares of AAPL at $240 per share---$24,000 in total---or buy an offsetting put contract at a higher price.
Potential
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The goal of a put selling strategy is to sell put options on securities that do not fall in value and keep the premiums from the options sold. It is an income generation strategy, which allows the trader to collect money and keep it if the strategy works. The put seller believes the security price will stay above the strike price of the option, while the put buyer is betting the price will fall below the strike price. The risk of put selling is that if the underlying security falls rapidly in value, the trader will generate losses much larger than the premium earned by selling the options. Selling puts is a strategy of earning small premiums over and over, with the risk of a very large loss if a trade goes the wrong way.
Considerations
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Put sellers are not allowed to sell put contracts and collect the premium without putting up cash or collateral to protect the trade against loss. An account approved for cash-secured put selling requires the trader to have enough cash in the brokerage account to cover the cost of the stock if the contract is exercised. Traders who are allowed to sell naked puts---puts without the cash to back them---must put up margin deposits of 15 to 20 percent of the value of the stock if the contract is exercised. Naked put selling is only allowed in the accounts of experienced traders, and most brokers require an account value of $100,000 or more.
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