Have you ever come across someone telling you that selling put options is a terrible idea?
They might have also told you that buying stocks is way better when it comes to earning a profit!
For someone that is learning how to trade options, which one is the smarter path to take?
Selling put options or buying stocks?
Why would you sell a put option?
First of all, what are the actual benefits of selling a put option?
Selling a put option allows you to collect option premium and own the underlying security below the current market price.
Learning how to sell put options for a profit takes hard work and lots of dedication.
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What is the risk of selling a put option?
For those of you that are new to options trading, what are the risks of selling a put option?
The risk of selling a put option lies with how likely the price of the underlying shares will drop below a specific price (the strike price) within a specific timeline (the expiration date).
If the price of a security's share drops below the strike price, the option seller will have to purchase 100 shares, for every put option they sell.
You might be wondering, how can I find out if a company’s shares are set up in a way that is suitable for selling a put option?
One way is to find a legitimate and reputable options trading coach with a great trading strategy.
David Jaffee teaches a trading strategy where his members can win up to 98% of their trades.
It's important when trading that you do not take on too much risk. You don't want to trade high risk, high reward, companies. Instead, it's best to build your account slowly and steadily.
What happens when you sell put options?
When you sell a put option, there are three possible outcomes:
- Option will be exercised
- Option will expire worthless
- Option will be closed early
When selling an option, the seller collects premium for agreeing to purchase the underlying security at the strike price.
If the option is exercised, or assigned, then the seller will purchase 100 shares of the underlying security, at the strike price, for every contract they sold.
In this scenario, the option seller can now run the wheel strategy to reduce their cost basis, while also participating in the capital appreciation of the stock.
The option can also expire worthless if the security is trading above the strike price at expiration.
Finally, the option seller can buy back the option in order to close out the trade.
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Is selling puts better than buying stocks?
It depends.
In general, selling puts is better than buying stocks because you can make a profit if the stock price remains above a certain price, doesn't move, or even if the price falls in value.
Additionally, it's a great way to acquire shares of your favorite stocks below the current market price.
Selling put options also provides a higher probability for profit.
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Conclusion: Selling Puts vs Buying Stocks
When done correctly, selling options can be a better way for traders to invest in the stock market when compared to buying stock.
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Frequently Asked Questions (FAQs) - Selling Options vs. Buying Stocks
What's the difference between stocks and options?
The biggest difference between options and stocks is that stocks represent shares of ownership in individual companies, while options are derivatives on underlying stocks that allows you to sell, or buy, insurance based on where you believe the stock price is headed.
Is selling options better than buying stocks?
Selling options can be a better choice when you want to limit risk. Options allow you to earn a stock-like return while investing less money. Options also allow you to acquire shares of stock below the current market price.
Is selling options better than buying options?
If you want to be consistently profitable, then it's important to sell AND buy options. You'll need to sell options to collect premium and acquire shares.
You'll need to buy options to protect your profits and reduce portfolio volatility while also taking advantage of market price extremes.
Is options trading more capital efficient than buying stocks?
Yes. Your online brokerage will require ~50% - 100% of the funds when purchasing stock, and you'll pay margin interest on the remaining 50% (if you're using a margin account).
With options, you can control ~100 shares of stock with only ~15% - 20% of the capital using Regulation T margin.
For larger accounts with Portfolio Margin, you can control 100 shares of stock with only ~5% - 10% of the notional value.
Stocks vs options?
Trading options allow you to be profitable in all trading environments (bull market, sideways market, grind down market and market crash).
It's much harder to be profitable when trading stocks because you'll have less flexibility.