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? Well, there are a couple myths surrounding the idea of selling put options. One of the most common misconceptions about this trading strategy is that it has a low probability of profit.
That’s absolutely not true!
Selling a put option is a great strategy if you follow the best practices. An important practice to follow is being okay with owning the security at a predetermined price, as there is the possibility of you being obligated to buy the security at a future predetermined price (the strike 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 company’s share drops below the strike price, the option buyer will have to purchase 100 shares, for every put option they sell at a predetermined price.
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 reputable options trading coach with a high win rate.
David Jaffee teaches a trading strategy where his students 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, the buyer can force you to buy 100 shares of the underlying stock, at the strike price, for every option contract that is sold.
There are two outcomes when selling a put option:
First, you get to keep the premium collected if the share price doesn’t drop below the strike price.
In this scenario, you make a profit.
The second outcome is you can buy the shares below the current market price once the put option expires (you'd get assigned the shares).
This is a great scenario if you want to own the shares below the current market price!
Not sure which companies to target when it comes to selling put options? Watch this online review on the best stock market strategy!
Is selling puts better than buying stocks?
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 if the price falls in value but doesn't fall below the strike price.
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.
In order to achieve this, we highly recommend that new investors practice, and learn, patience and discipline when entering new trades.
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Conclusion
When done correctly, selling options is a great way for traders to invest in the stock market compared with buying stock.
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Frequently Asked Questions (FAQs)
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?
Options can be a better choice when you want to limit risk to a certain amount. Options can allow you to earn a stock-like return while investing less money, so they can be a way to limit your risk. 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. Even when using margin, your brokerage will require ~50% of the funds when purchasing stock, and you'll pay margin interest on the remaining 50%.
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.