How to Sell Puts for Buying Stock
Selling puts for buying stock is a good strategy to use if you wish to create a steady income stream or want to purchase a stock at a discounted price. It is also a more relaxed way to trade the markets that doesn't require you to sit at your computer for hours at a time. As with any trading strategy, however, there are risks involved and you should be well aware of them before selling your first options contract.
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Instructions
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Determine the trend of the overall market. You can do this by looking to see that both the S&P 500 and DOW are above their 200 day moving average. Never sell an option on a stock if these indexes are below the 200 day moving average.
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Select a stock. You want to begin by looking at the trend of the stock. Make sure that the stock is in an uptrend by making sure that it is above its 200 day moving average. Also, make sure that there are no earnings or dividend dates in the next month, as this could cause the stock to spike in price.
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Use Fundamental analysis. This is looking at things such as a company's earnings, cash flow, and debt. An easy way to do this is with a subscription to Investors Business Daily (http:www.investors.com). You type in the ticker symbol and it provides a stock grade from A+ to E. The formula comes from William O Neil's proprietary system discussed in his book, "How to Make Money In Stocks."
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Select a put contract to trade. When you write an options contract you are selling it to a buyer who is hoping that the price of the stock goes down, which will make the options contact more valuable to them. As the seller of an options contact your hope is that the stock price will either stay the same or increase by the contract expiration date. If you are a very conservative trader you will want to select an option contract that is "In The Money." If you are less conservative you can buy an "At the Money" contract, and if you are a very risk oriented trader you can purchase "Out of The Money" contracts, but you should only do this once you know what you are doing. You will want to purchase a contract with only three to four weeks of time value left on it.
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Write the contract. Let's use Apple (AAPL) as a candidate for put writing. If Apple is currently selling at $210 per share I can write a contract with one month to expire with a $200 strike price on it, which is "In the Money," and right away I will receive a premium of $230 per contract. Now if the stock is still above $200 when the option expires on the third of the month then I will get to keep all $230. But if the stock falls below $200 I will start losing money on the premium. For instance, if the stock is at $199 I will then only keep $130 of the premium. Thus I will not actually lose any money until it falls below 198.70, which is where the break even point is. If at expiration the stock is trading below $200 then the put options could be exercised and I would be forced to purchase 100 shares of Apple stock for every one contract that I wrote. However instead of paying $200 per share my net price would be $200 minus $2.30 (the premium that I collected per share) equals $198.70, so essentially I'd be getting the stock at a discount.
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Do it again. If the option expires worthless then you can do the same thing for the following month and collect another premium.
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Tips & Warnings
Know your options. If you are not interested in purchasing the stock, and only want the income from writing the options then you might be better off doing credit spreads than selling puts.
