Put Writing Strategies – What Are They & How Do They Work?
When you plan to speculate price movements or hedge against market fluctuations, writing a put option can be an effective measure. It means selling a derivatives financial contract in which you agree to buy an underlying security at a predetermined strike price and expiration date.
Now, there are several strategies by which you can write your put options. Keep reading this blog to learn more about them.
What Are the Best Put Writing Strategies?
Here are some of the best put writing strategies you can implement to take advantage of market movements:
- Bull Put Spread
A bull put spread is a strategy you can use when feeling moderately bullish. To implement this, you must buy one Out-of-The-Money (OTM) put option and sell off an In-The-Money (ITM) one. All options, in this case need to have the same underlying asset and expiration date.
In this case, your profit will come from time decay as the short put option will lose value faster in comparison to long put option.
- Bear Put Spread
This strategy will come in handy when you are feeling slightly bearish. It involves purchasing a put option and selling another at a slightly lower strike price but with the same underlying security and date of expiration. The difference between the two strikes will depend on how aggressively you want to implement this strategy.
Your total profit using this strategy will be equal to the difference between the two strike values, less total options premium paid.
- Short Put Ladder
When you anticipate that the market will make a significant downward move, it is a smart idea to use a short put ladder. This strategy involves purchasing one At-The-Money (ATM), one OTM put, and selling one ITM put option.
In this regard, your upper breakeven point will be equal to the short put option’s strike price after deducting the received premium amount. Inversely, your lower breakeven point will be the sum of the two long put strike prices, less the short put’s strike price and adding the net received premium.
- Short Put Butterfly
A short put butterfly spread strategy has three parts. First, you need to sell off a put option with a higher strike value and buy two puts at comparatively lower strikes. Then, you have to sell a put option with an even lower strike value.
The underlying asset and date of expiry must be the same for all options. Moreover, the strike price values need to be equidistant. Here, your net profit will be equal to the net credit, less the total commission amount. Alternatively, maximum loss, in this case, will be the difference between the centre and lower strike values, minus the net premium amount.
- Put Ratio Backspread
If you anticipate that the market is going to exhibit another downtrend, the put ratio backspread is what you should choose. It is a bearish strategy that aims to secure profits from the underlying asset’s price volatility.
To construct this strategy, you need to purchase two puts at OTM and sell a third one at ITM. Now, for buying and selling these options, you have to follow a certain ratio. Usually, traders follow – 2:1, 3:1 or 3:2.
After you implement this strategy, your profit potential is unlimited if the market continues to go down. If it goes up, it is limited, and in case the markets remain stable, you incur a predefined loss.
- Short Put
You can write a short put option when you anticipate the underlying asset’s price to exhibit a moderate rise or remain stable. It involves selling a put option with a strike price which is almost similar to the underlying asset’s market value.
Here, your goal is to book profits from the premium amount you receive and the option to expire unexercised. The breakeven point in this case is the contract’s strike price, less the premium amount.
In this strategy, you can face unlimited loss in case the buyer decides to exercise his/her right or the underlying asset’s market price depreciates below the strike.
While trying out new put writing strategies for the first time, there may be a chance of incurring losses. However, it is important that you must identify what went wrong and try to correct it on your next try. This way, you get to learn from your mistakes and become an experienced options trader. Moreover, experts recommend using a stop-loss order to prevent significant losses if the market moves against your expectations. It is also suggested to exercise these trades on paper first before implementing with actual capital
Frequently Asked Questions
What is the best time to sell a put option?
The best time to sell a put option is when investors feel that the underlying asset’s price will either remain stable or show a certain downtrend. In order to accurately predict these movements, keeping track of political, social and economic events is crucial.
What are the advantages of writing put options?
Some of the greatest benefits of selling put options are that you can reap gains from time decay if you sell the contract when it still has value. Moreover, you also get the premium amount, which at times, can be enough to cover your losses.
What is an options premium?
An option’s premium is the amount of money that the contract seller receives and the buyer pays to enter a derivatives agreement. This value is determined by several factors like the underlying asset’s market value, time remaining till expiry and the difference between the market and strike value.
What is the difference between call and put options?
Call options give investors the right but not the obligation to buy a fixed quantity of an underlying asset at a fixed strike price and date of expiry. On the other hand, put options provide the right to sell an underlying security and all other factors remain the same.