Selling Put Options For Income - Risks and Benefits to Writing Naked Put Options

Dec. 10, 2010 - PRLog -- Selling Put Options For Income

One of the most popular investment strategies recently has been to write naked put options. This strategy has a lot of benefits, but of course comes with its share of risks as well. By understanding both, investors will be better equipped to decide whether or not such a strategy makes sense for their specific portfolio.

How it Works

The key to this strategy involves writing an out of the money put option. For example, writing a $90.00 put on a stock that is trading at $120.00 is an out of the money put option. While this gives the option buyer the right to sell their underlying security at $90.00, it could be unlikely that the $120.00 security will drop that low. This provides income to the option writer and normally at reduced risk if that $120.00 is entirely unlikely to drop to $90.00 (with that being said, the $90.00 put option would not generate as much income as, say, the $110.00 option).

In terms of margin, the option writer will be required to hold a certain level of margin in the account depending on the price for that option. When volatility increases and/or the security price decreases, the option writer can be expected to receive a margin all for their account. When the price increases and/or volatility decreases, there will be less of a margin requirement. Get Internet #1 - Selling Put Options For Income @ http://tradingcure01.webs.com and be Successful forever!

Benefits

Writing naked, out of the money options provides the options writer (seller) with a decent income. Unless markets are highly volatile or uncertain, it can be unlikely that the option writer will be forced into buying a security that he or she does not want to own in the first place.

As well, time decay is unavoidable. Each passing day will erode the value of that option, regardless of what happens to the underlying security. This means the writer will automatically generate income, even if the underlying security price remains at the same level.

Risks

As with all derivative investments, there are risks to writing naked options. With the naked put option, the investor could be forced into taking on securities that he or she might otherwise avoid if the market collapses or experiences an aggressive correction. This was certainly the case in May 2010 when, after a period of sustained, lower volatility, the market corrected and volatility spiked.

While isolated, such risks certainly exist and should be kept in mind when evaluating a potential position. Investors are always wise to refer to an appropriate Probability calculator before making trades.

Summary

To summarize, writing naked, out of the money put options can provide a steady stream of income into one's investment portfolio with as much or as little risk as an investor wants. Of course, this steady stream can be put at risk with as little as a sudden change in market sentiment, which pushes volatility up and in the case of a market correction, will push the underlying security's price close to the strike price of the put option. The result: having the security put or having to satisfy a margin call. Get Internet #1 - Selling Put Options For Income @ http://tradingcure01.webs.com and be Successful forever!

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