Selling puts for income options is one of the first income strategies we teach in our Cash Flow Options course. It’s fairly simple, has a high win rate, and lets you make money due to the passage of time. And yet to the budding trader, the concept of selling a put (AKA the naked put) may be difficult to grasp.
If you’re struggling with this strategy, see if the following analogy helps put it into perspective.
Suppose I was an insurance company selling protection against earthquakes. I have 1000 customers paying me $50 per month for their policy. All told, I’m receiving $50,000 in monthly revenue. What am I as the insurance company hoping?
Why, that an earthquake never occurs of course! Think of it this way – I sold people protection against an event that never ended up transpiring.
Now, how might I accomplish something similar in the stock market?
Let’s begin by drawing two parallels.
- We’ll define an earthquake as a 10% sell-off in the stock market.
- Earthquake insurance, then, would be something that protects an investor if the market does indeed sell off 10%. This “something” is commonly referred to as a put option.
Investors purchasing put options are essentially paying some premium for earthquake insurance. If the 10% sell-off doesn’t occur the put simply expires worthless causing the put buyer to lose whatever premium he paid to buy the insurance in the first place.
As a put seller you’re the insurance company. If I sell a put that sits 10% out-of-the-money I’m essentially betting the stock will not drop to that price. If I’m right, the put expires worthless, and I’m able to pocket the original premium I received. Then I can sell another put for the next month, and the month after that, and the month after that, and so on.
It’s really as simple as that.
If the idea of starting your own insurance company sounds enticing then consider yourself the perfect candidate for an options education.
- Jonas Taylor is a financial expert and experienced writer with a focus on finance news, accounting software, and related topics. He has a talent for explaining complex financial concepts in an accessible way and has published high-quality content in various publications. He is dedicated to delivering valuable information to readers, staying up-to-date with financial news and trends, and sharing his expertise with others.