Premium Report

Understanding Put Selling

Karim Rahemtulla, Head Fundamental Tactician

When you sell a put option, you are saying to the buyer (the person you are selling the put to) that you want to buy the stock at the strike price you sold the put at. It’s an obligation that you can get out of by buying back the put – but it is an obligation nonetheless. For taking on that obligation, the put buyer gives you money (you’re the put seller, and anytime you sell anything in the market, you will receive money) immediately.

That money is yours to keep no matter what. But if you buy the put back, you will give some of that money back – what’s left over is the profit. If you give back more than you paid for it, you are taking a loss.

There are three ways this trade could end…

1.) You get “put.” That means you have to buy the stock at the strike price. The put buyer can assign you the shares at any time. But it makes no sense to assign you the shares if they are trading above the strike price, as you can sell those shares into the market immediately. So if you sold one contract (100 shares) with a $17 strike price and you get put, you will need to pay $1,700 to buy the shares for less than what you received when you sold the put. If you received $1, then your cost would be $16.

2.) You buy back your puts early at either a profit or a loss. If that $17 stock is trading at $12, you are now down $4 at least (counting the $1 you received for selling the put). If the $17 stock is trading at $20, you are not up $3. Your gain is limited to the $1 you received when you sold the put.

The return on a put sell is calculated based on your margin requirement, which is 15% for most people (determined by your broker). So the amount you put up is $17 times 15%, or $2.55 per contract. If you made the full $1, your return on margin is 39% ($1 divided by $2.55). In your brokerage account, the put will be displayed as a profit or a loss based on your $1 cost.

The goal for a trader is not to get put. The goal for an investor is to get put at the right price.

3.) The shares close above your strike price at expiration, and if you have chosen to hold that long, the put will expire worthless and you need to do nothing. The money that you received to sell the put is all yours.


Getting Permission From Your Broker to Sell Puts


This is arguably the hardest part of selling puts and why many will not be able to participate in this strategy. For put selling, you need Level 4 options permission. That’s only one level from the top.

Brokerage firms have strict company policies about whom they will allow to use certain strategies. But at the end of the day, it’s all about liability. When you sell a naked put, the broker is at risk in the event that you can’t pay to cover your obligation.

So they want three things from you: experience, cash, and protection – for their butts to be covered.

Experience is something you can demonstrate over time by first being an active options trader.

You could also sell cash-covered puts, but that’s not very efficient. When you sell a cash-covered put, you are required to have all the funds in your account to cover the put sell. Basically, you are doing a covered call and not enjoying the dividends or the benefit of margin. But selling cash-covered puts would give you experience, and you could do this type of trade in your IRA as well.

Brokers will require you to have an account of at least $25,000 – sometimes more. This, again, is because they want to be able to sell other securities in your account in the event that they have to. Every broker has a different requirement, and it’s up to you to talk your broker into allowing you to do this.

To get started, contact your broker and inform them that you want to sell naked puts. If you don’t have experience, they will be quick to say no. That’s just the way it is. Some full-service firms will work with you, but you may be paying more in commissions.

If you can’t do put selling yet, watch and learn how we do it in The War Room. That will give you more ammo for your future conversations with your broker. In the meantime, keep bugging your broker about it!


How to Sell Puts


Let me preface this by saying that I have used this particular strategy since April 2017 with real trades from my readers. Between then and now, I’ve made 58 put sell recommendations. The goal was to “win” 80% of the time. By winning, I mean that we would avoid getting put. However, it also meant that we would likely get put 20% of the time.

That was fine by me, since the companies that we sold puts on were companies I would not have minded owning at the time that the puts were sold. Things change fast, and sometimes we needed to adjust and it was too late. But by using this particular strategy and position sizing, we minimized the bad calls.

Of the 58 trades, we were put twice and took four losses (including the two that were put to us). That’s a 93% win rate. I expected to be put more often, but the safeguards I incorporated worked better than I expected. Regardless, I will stick to the 80% number as the target we are trying to achieve going forward.

So there will be losses – that’s inevitable.

But by position sizing, you can limit the effects of any loss.

I usually sell longer-term puts, sometimes even long-term equity anticipation securities (LEAPS). That’s not to say I don’t do short-term puts, but certain parameters must be met for that.

The average holding time in that group of 58 trades was just over three months… even for the LEAPS. This is because we almost always closed out the trades early once our target returns were met.

When I look for a put sell candidate, I use the same criteria I would use if I wanted to own that stock. I don’t chase premium – that is the quickest ticket to the poorhouse. Sure, I could get a ton more if I chased a company like Roku, Beyond Meat or Tesla, but I know that the probabilities of being put on such a company are very high. And I don’t want a call from the broker asking me to pony up a ton of cash for a trade that went south quickly.

I will only sell a put on a company if I can get a strike price that is 20% to 50% below the current market price. The return on that trade must be in the double digits. And the probability of being put must be lower than 20%. With that criteria, I have been able to minimize losses and maximize gains.

The goal is making at least 50% of the premium that I received when I sold the put. So if I sold the put for $2, I am looking at making $1, or 50%, before I close out the position. That is why I don’t really care about the time horizon as much as I care about the criteria. I have sold many LEAP puts that had more than a year until expiration and closed them out in less than a couple of months.

The key to understanding how this is done is understanding how options are priced and how they react to moves in share price. It’s about time, volatility, strike price and the company selected.

Market downdrafts can be negative if they last, but they will provide even greater put sell opportunities. Some of my best put sells have occurred during a market crash or correction.

That is also why it is critical that you position size, even when you are selling puts.

By having a 20% to 50% cushion on the downside, you can eliminate the need for further protection. However, that does not mean you can’t buy protection or that you should not adapt your strategy to allow you to sleep better or invest less cash.

The worst-case scenario is if we are in a sector that is getting pounded mercilessly or if we are in a company that is cooking its books. Again, that is why you must position size.

When I issue the first put sell, it will contain the following information:

1.) The rationale for the underlying stock. This is critical because there has to be a compelling reason to ultimately own the shares in the event that we are put. I do not chase premium.

2.) The options symbol.

3.) The price at which we want to sell the put for. I will always give you a limit price. A slight deviation is fine, but I will try my best to check to make sure the volume and liquidity are good. Of the 58 put sells I issued over the past couple of years, there might have been one or two instances when we couldn’t get filled right away. Remember, use limit orders and wait for the price to come to you, even if it takes a day or two. I will adjust the price if necessary.

4.) The expected return from the trade and our “danger points,” which we will consider covering in the event it goes against us.

5.) The probability of being put and the discount to the market price. The return percentage is what you should use as your guide, in tandem with the discount. So if you can’t get the discount and the return, the trade should not be placed.


How to “Trade” Puts


I know that most of you don’t want to own the underlying stock. For the most part, we are all traders, and we trade to make profits.

But – and this is very important – when you sell a put, you always need to know in the back of your mind that you could get put despite your best efforts.

Here is an example… and why I will stay away from certain stocks.

Say you like a biotech stock and the stock is trading at $15. The $13 puts for that stock are trading for $2, and you think that’s a fantastic amount of premium to take in. I agree. But, because of the nature of the stock, the chances of you getting put are high.

If the biotech stock announces bad news after the market closes or before the market opens, guess what?

That stock might open at $2 per share when the market opens, and you are down $11 ($13 minus $2). That’s a big fat loss. And you can bet you will be put immediately if that’s the case.

I will also avoid trading too many puts in one sector. Experience has taught me that even companies unrelated in their operations, but still within the same sector, will all perform the same way regardless of fundamentals.

What should make sense doesn’t.

So when I trade puts, this is how I do it… and how I will recommend that you do it too.

First, we only sell puts on companies that we want to own.

Second, we will sell puts with the goal to cover that position before expiration… usually long before expiration.

Knowing that options volatility is low right now means that we may have to go out several months to get the type of premium we want and the discount to market that we need. This will change as the market changes. In a volatile market with a downward bend, we’ll pick up more premium and have shorter holding periods. The opposite is also true. In a less volatile, upward-trending environment, we will have fewer opportunities.

But just because the market is less volatile does not mean there aren’t sectors within the market that are. I try to find the combination of volatility, premium and expiration.

When we sell a put, the goal is to buy that put back when we hit 50% of the potential return. For example, if we sell a put for $1, we will buy it back when we get to $0.50. If it’s a $0.20 put, we may hold until expiration, and sometimes we may take 30% or 40%. But rarely will we hold beyond 50%.

We will take advantage of time value to accomplish this when we sell LEAP puts. Time value is one of the biggest factors in options prices, and every day that we get closer to expiration, an option will lose time value.

Combined with our big discount, the option value can decrease quickly if the share price stays the same, goes up or doesn’t go down much. That is how we will close out a one-year option in a matter of a few months.

Know this – we may be in a position for much longer than a few months, and if that isn’t for you, you can close out early or skip the trade.

Always understand that if a put has premium, it’s there for a reason. In all my years of put selling, it’s become apparent that high put premium can also be a directional guide for the shares. In other words, you may want to think about buying puts instead of selling them! But while that rings true for the shorter term, we would not have racked up a success rate of more than 90% if that were completely true for the entire holding period.


Your Account Will Not Always Be Accurate


When selling puts, your account is usually marked at the offer price or between the bid and offer. That can distort the actual value of the holding. Be ready for that, and please refrain from posting comments in The War Room like, “Why is my put showing that I am down 50%?”

Always look to the stock price. If the stock price is not down, why would your put be down so much if not for the way it is being marked by your broker?

And in the early stages of a put sell, the underlying shares may go down and your put may show a loss. The loss is misleading in magnitude.

For example, if you sold a put for $1 and now it’s showing $2, your account will show a 100% loss. That is true, technically, but if your strike price is $10 and the stock is at $15, you will only realize a loss if you cover. If the share price remains at $15, or if it goes lower but does not close below $10, you will make 100% of the premium.

When you sell a put, you sell to open. Each contract you sell obligates you to buy the underlying shares if they close at or below that price at expiration, or you can be assigned the shares at any time and for any reason. But if the shares are trading above that price, you will not usually get put.

When you close a trade, you buy to close the same number of contracts. Of course, you can continue to maintain a position if you want, but once we issue a sell alert, we will not follow the company in the portfolio anymore.