Put options can be deployed when opportunities are presented in high-quality stocks that have had a meaningful sell-off. If the stock of interest is a long purchase target, then one has an option to “buy” the stock at an even lower price at a later date while collecting premium income in the process. This is called a covered or cash secured put option, covered in the sense that one has cash to back the option contract when looking to initiate a future position in an individual stock. In the event of a covered put, this is accomplished by leveraging the cash one currently has by selling a put contract against those funds for a premium. If the stock isn't assigned then gains were realized on the option itself without owning or being assigned any shares via realizing options premium gains.
Selling a put option will take on the obligation to purchase the shares of interest which currently trade at $100 per share. A put option was sold at a strike of $95 for $2 per share premium for a one month contract. The option seller takes on the obligation to buy the shares at $95 (effective price of $93 including the $2 per share premium) a month from now. The seller of the put contract believes the shares will trade sideways, appreciate or decline but not decline below $95. If the stock remains above $95 through expiration then the owner of the shares could not exercise the option and assign shares to the seller since the price is not in-the-money. In this case, the put option seller collects a premium from the put option buyer and makes money without owning any shares.
From the stock owners perspective, he/she is buying the right to sell the shares at $95 a month from now when the current price is $100. If shares fall to $90 then the owner of the shares would exercise the option and assign shares to the put seller. Why sell the shares on the open market for $90 when the owner can sell them to the put seller for $95 and avoid any losses below $95? In this case, the put option seller collects a premium from the put option buyer and then is assigned shares that are higher price then the open market.
Founder and Managing Member
Stock Options Dad LLC
A Registered Investment Adviser (RIA) firm