Selling Puts – My complete and practical guide

Selling put options is, in my opinion, the best method to learn about the mechanics of option trading and to start your own journey of trading options the smart way by receiving a premium and generating cash flow.

If you are a beginner in options trading and you start your trading journey with this straight-forward strategy (just like I did), you will quickly learn that the general reputation of options trading, of being risky sophisticated investments only expert traders can understand, is not true at all. It is a clear lack of understanding that makes that the big public doesn’t see that options trading done in the correct way, doesn’t have to be that difficult, dangerous and risky at all and that it can be very useful and profitable strategy for any individual investor.

If you are past the beginner stage and you have been trading options for a while now, then this information may guide you to adjust your trading strategy towards selling puts for a premium and also provide the information towards higher probability of making profits.

In this comprehensive resource page, I am going to cover everything I believe you need to know about selling put options safely and successfully as a beginning option trader. Whenever I explain options to a friend, I am basically always telling about how I’ve got started selling puts and collecting a credit and why it is still my favourite investing strategy. It basically offers fantastic returns while being enormously flexible and easy to manage if you respect some basic principles.

I want to suggest to bookmark this free resource page because it is going to be packed with info and examples you’re probably going to want to come back to again and again as a reference (and also consider sharing it with friends and family you believe would benefit from it).

Table of contents

1. Explanation of the strategy
2. Characteristics of the put selling strategy
3. Reasons why people by puts
4. Two great reasons why I prefer selling puts
5. Choosing the appropriate option parameters – strike and expiration to match my goals
6. Different ways to manage the strategy
7. Has this strategy produced great results?

1. Explanation of the strategy

If you are completely new to options trading, this chapter is about getting you to know and understand the basics of selling put options. I will explain in plain words what it is and what elements are important to understand when trading put options.

A put option contract is an agreement between a seller and a buyer (a contract between two parties), that gives the holder (the buyer or owner of the put option contract) the right to sell 100 shares of a determined underlying stock at a specific share price (aka the strike price) by a set date (aka the expiration date). The seller will receive a premium (the price of the option) for selling that right to the buyer. In return for receiving the premium, the seller of the put option assumes the obligation of buying the underlying instrument at the strike price at any time until the expiration date, as specified in the option contract.

The seller of an option contract has the intention to buy the same option contract back later at a lower price (and thus to be released from his obligations) or waiting until expiration and hoping it will expire out of the money (then it is worthless). In both cases het seller of the option contracts makes a profit.

It always helps to understand and to explain things by using examples. I will also do this in this guide – Throughout the site I will use pictures and visuals form the International Brokers platform and the Tastyworks trading platform to demonstrate my examples (pictures and the text in the grey boxes). I am currently using both platforms with great satisfaction for my trading activities.

Example: Imagine Apple shares (AAPL) are trading at about $132. John wants to buy a put option contract that gives him the right to sell the 100 shares of Apple stock, he already owns, at a set strike price of $110.00 per share, before the contract expiration date of 19 February 2021, and for this right he pays an option premium $1.18 per share. In total he will have to pay $118.00 to the seller (in this example I am the seller) to buy this option contract.

This is a lot of information at first, so let’s take a closer look to the different informations here.

The option prices or premiums for the different option contracts are listed in the so-called Option Chains (see picture below) which includes the market makers current bid and ask prices (just like stock quotes) for every option contract with a specific strike price and expiration date. So all elements defining an option contract can be found in the option chain.

Let’s break the basic contract elements of this example down to clearly understand every important aspect of an option trade.

It is a RIGHT : This means that the holder of the option has the choice (hence the word option) to sell his shares if he wants to. This basically means that normally he will only do this (this is called “to exercise the option”) if it is profitable to do so. If the owner of the put option doesn’t exercise his right at any moment at all, the option will expire completely worthless at the expiration date, because the right to sell comes to an end at that date.

It involves an UNDERLYING instrument : When we are talking about stock options (which we do), the underlying simply refers to the shares of “underlying” stock, that the contact is about.

In the example the contract refers to the underlying stock of APPLE (ticker symbol: AAPL).

There is an EXPIRATION DATE : This term speaks for itself, I guess. The owner of the option contract has time to exercise his right until the contract literarely expires at the expiration date. For stock options, option traders can select weekly or monthly expiration dates. The monthly expiration dates are usually on the third Friday of the expiration month. It is paramount to understand that if an option contract expires, the holder of the option contract no longer owns the right. This basically means that after expiration the put option he owns is worthless… zero. The seller of the put option has no obligations anymore after expiration.

In the example the expiration date is 19 Feb 2021, which actually means that the option expires when the option market closes that day.

Important remark: you should be aware that US stock options can be exercised on any business day, and the seller of the put option has no control over when he will be required to fulfil his obligation. Therefore, although rare, early assignment before the expiration date (assignment happens when the owner of a put exercises his or her right to sell the shares to the seller of the put option) is a real possibility that must be considered for US options. European stock options are contracts were the execution is in general limited to its expiration date.

At a set STRIKE PRICE : The strike price is the agreed, contractual price at which the holder (or buyer) of the put option can sell his shares to the other party of the option contract, being the seller of the put option.

In the example the strike price is set at $110.00. The buyer of the option contract has the right to sell his 100 shares of AAPL to me (the seller) at $110.00 (no matter what the actual share price is on the stock market) and I will have to buy the shares (it’s my obligation) when his exercises that right.

The stock price, at which the shares are trading on the stock market, in relation to the strike price of the put option will however determine if exercising the put option is profitable or not.

In other words, if the stock is trading below the strike price, it is profitable for the owner of the put option to exercise his right and to sell the shares at the strike price, because he will get to sell his shares at the set strike price instead of at the lower market price. If the stock closes at expiration below the strike price, the seller of the put option will automatically be assigned the shares by the broker/market maker. This situation is unfavourable for the seller of the option contract, as you can see on the Profit-Loss Diagram (red area) below.

In our example, imagine the stock AAPL trading at $105, then the intrinsic value of the option if exercised equals $110 – $105.00 = $5.00 per share. In this case it would be beneficial for the owner of the put option to actually exercise his right because he will receive $110.00 per share instead of the $105.00 per share if he would sell his 100 shares in the open market (he will receive $500 more in total).

On the other hand, if the stock is trading above the strike price, it is NOT profitable for the owner of the option to exercise his right and to sell the shares at the strike price, because he will get paid less, for selling his shares this way, than the amount he would receive, if he would sell them in the open stock market. He would actually loose more money when doing so. This situation is favourable for the seller of the option contract, as you can see on the Profit-Loss Diagram (green area) below.

The seller receives a premium : this is the great part (because in my approach I want to be the seller of the put option). The premium, or the option price is the amount that the seller will receive per share. Since each contract represents 100 shares of the underlying stock, the total received, is the premium per share x 100 for each contract you are trading.

In this example the seller (me) of this one put option contract will receive $118 up front (before commissions). If I succeed to buy the same option contract back later at a lower price or if the option contract expires at expiration date out of the money (worthless), then I make a profit and I can keep the received credit as a form of income or cashflow.

Sometimes options are briefly written as AAPL 110 Put 19 Feb 21.

Now the basic elements of a put option trade are explained, let’s find out why people would buy or sell these put option contracts in the first place.

2. Characteristics of the put selling strategy

a. Profit Loss (P/L) Diagram

For our example the AAPL Put Option with the 110 strike price and a premium of $1,18. This is what the Profit Loss Diagram (P/L) will look like:

b. Maximum profit – Maximum Risk

The maximum profit is limited to the premium received at the start of the trade (less commissions), and this maximum profit is only realised completely, when the underlying security ends up at or above the put option’s strike price and the put option is held to expiration date and expires worthless. In that case I, the seller of the option, can keep all the initial cash received, which is also the total profit.

Below the strike price the profit declines in proportion with the underlying price.

If I decide to sell before expiration date the profit is the difference between the received credit for selling and the debit I have to pay for buying back the option.

The maximum risk is the strike price x 100 minus the received premium. Of course, this maximum risk only happens if the price of the underlying would fall all the way to zero (for those who think that Apple stock can be worthless in a couple of weeks time… then the Max risk is there.)

In our example: Max Profit = $118.00 and Max Risk = $10,882.00. It is important to put both amounts into perspective so let’s explain more into detail for our example how we need to understand both notions:

As long as the share price stays above the $118.00 strike price I (the seller) will get to keep the premium premium completely at expiration date and have Max profit. If I would decide to buy the option back before expiration date (closing the position), then my profit will be determined by the debit (equal to the option price that it is trading at on the option market) I have to pay for buying back the option. My profit will be the difference between the received credit and the payed debit.

If the stock goes down significantly, let’s image to $75.00, and the owner of the option will exercise his right and sell the 100 shares to me, I will have to buy the shares at $110.00 per share for a total of $11,000.00. With the shares only being priced $75.00 on the stock market, if I were to sell them immediately, I would make a loss of $11,000.00 – $7,500.00 – $118.00 (credit received) = $3,382.00. If I would decide not to sell the shares immediately, because I am hoping for a recover of the share price, I will still have that virtual loss in my account.

The maximum risk I have with this trade is when the share price drops completely to zero. In that worst case scenario, I will still have to buy 100 shares of AAPL for the total amount of $11,000.00. Since the shares are priced at $0 on the stock market, I won’t receive anything for them if I were to sell, so the maximum loss (or risk) is $11,000.00 – $118.00 (credit received) = $10,882.00.

This can only happen if AAPL becomes worthless. This may be hard to imagine for AAPL but it is important to understand the risk when trading in all kinds of stock. As we will discuss below, a smart choice of the strike price will mitigate for a large part this possible risk and turns the odds in our favour.

If the notions of “opening and closing option positions” are still unclear to you, these notions are explained more extensively in an other article on this website.

c. Break-even at expiration date

The break-even point (BEP) at expiration when selling a put option is the strike price minus the received premium.

In our example: the BEP is $110 – $1,18 = $108,82 meaning I (being the seller) will make a profit when the share price is above the BEP and a loss when the share price is below this BEP at expiration.

3. Reasons why people by puts

There are basically two reasons why someone wants to buy a put option:

• the buyer, who also owns the shares of the underlying, is concerned that the share price will fall, and wants to protect his stock investment, by buying the right to sell the stock at a fixed price in the predetermined time frame (it is very similar like he is buying an insurance against a price drop and the optimum premium is the insurance premium)

• the buyer, who doesn’t own the shares of the underlying, is outright bearish on a stock and looking to speculate on a downside move of the share price. He is looking to buy the put option at a lower price and sell the same put option at a higher price after the price drop, and make a profit doing so (if you are new to options trading and don’t know how options prices change, don’t worry – it will be explained more in detail in a later section on this website).

To demonstrate the second reason, let’s take a look at the prices of the options in the option chain below. You will notice that the options that have a strike price above the share price, are priced higher than the options with a strike price below the strike price. In the AAPL options chain below, the share price is $132.00

Imagine an option trader who believes the share price will drop in the near future. If he for example buys an option contract at strike price $110.00 when the share price is around $132.00 as in the graph above, he will pay a premium of $1.03 per share or in total $103.00 to buy this option contract. He is actually hoping that the share price will drop (white arrow), which makes the prices of the options at lower strike prices (and also at $110.00) become more expensive.

Imagine for the option chain above the share price was to drop to $110.00 and the premium of an at-the-money (ATM) option would be the same as it is in this option chain, then the option would become worth around $7.00 (between $6.00 and $8.75). When he then sells his option contract to close his position, he makes a benefit of the credit received (for selling) minus the debit (paid for buying the option at the opening of the trade): $700 (credit) – $103 (debit) = $597 of profit.

This sounds great, but there is one big but, he has to be right that the stock drops or he will lose money and if he holds the option until expiration he needs be right that the share price is below the strike price or he will loose the complete premium he had paid for opening the position. So basically he has to be directionally right or he will loose his paid debit.

4. Two great reasons why I prefer selling puts

Now on the seller side (the side I want to be on), there are in my opinion better reasons to sell a put option:

A first good reason, can be that I actually want to buy the shares of the underlying stock but not at the current trading price but at a lower (in my opinion more correct) price. When I sell the put option, I receive the premium and if the stock price drops lower and to a level below the strike price I will get assigned and I can acquire the stock at the lower strike price.

Selling put options this way, looks a bit like an alternative to placing buy limit orders, with the extra parameter of the expiration date but with the advantage of receiving a premium that reduces the cost basis of the shares if assigned. Just as with a buy limit order, the selling put option strategy does not guarantee that you will actually get to buy the shares if the price remains above the specified limit or strike price.

In our example, let’s imagine that AAPL shares are trading at $132, but I am only prepared to buy them at $110. I can either wait and buy them on the market when they trade at $110, or I can sell one put option with strike price at $110, and receive a credit (the option premium) of $1.18 per share. If the shares are assigned to me when the stocks drops below $110, then I will have bought 100 shares of AAPL at $110, in total for $11,000. And I have also received (to keep) the premium, so my cost basis is actually lowered to $11,000-$118 = $10,882. The premium reduces the cost basis per share to $108.82. It’s like acquiring stock at a discount.

Now, if the stock wasn’t assigned to me because the share price didn’t drop below the strike price and the put option contract has expired, I obviously don’t had to buy the shares but I still got to keep the option premium of $118.00 as an income. If my opinion on the stock hasn’t changed, I can basically repeat this process again, and again, receiving another credit (the option price) each time.

If I have the cash reserved and ready in my account to pay for buying the stock when assigned, this strategy is also referred to selling cash secured puts.

The closer the strike price, of the sold put option, to the actual share price, the higher the chance that the share price may go below the strike price and the higher the probability to get assigned. So we (sellers of premium) are for a large part in control of the chance that you will get assigned by the deliberate choice of the strike price.

A second great reason to sell a put option is to generate income or cash flow into my account by receiving the credit or premium. The goal of the trade is to keep the complete premium at expiration date when it expires out of the money (worthless) or at least to make nice profit when I decide to buy the option back at a lower price before expiration.

In this case, in order to achieve my goal, I need to make an assumption on the evolution of the share price within the time period of the option contract. When selling a put option this assumption is that the share price will not drop below the strike price. In other words, selling the put option is only beneficial if the share price goes up, stays the same and it may even go down as long as it stays above the strike price level. In all three cases this trade will make a profit.

Imagine that the stock of AAPL has just fallen to $132, and that I believe that the downtrend has come to an end and the share price may start going up again. And I make the assumption that it will certainly won’t drop below $110.00, and I decide to sell a put option AAPL with strike price $110.00 with expiration in 47 days.

There is a very important difference between trading put options this way and trading stocks (buying and selling shares). With trading options this way, I don’t need to be right all the time about the direction of the share price, up or down. When trading shares, I have to be correct about the direction, or I will lose money. When selling puts this way, I am profitable if the share price goes up, stays the same and it may even go down as long as it stays above the strike price level. And with a wise choice of strike price, I can even use a mathematical model to determine the probability of being profitable to help me pick the strike price.

In other words, I will make a profit if the share price goes up, stays the same and even if it goes down as long as it stays above the strike price level of $110.00. In all three cases this trade will make a profit. As you notice I don’t have to be directionally right to make a profit as it is the case for the buyer of shares and the buyer of options.

Both of the above reasons work perfectly for me, although my initial goal is not to acquire stocks but rather to sell the options for receiving the premium as an income, as cashflow towards my account.

5. Choosing the appropriate option parameters – strike and expiration to match my goals

My goal with options trading is to continue to be highly profitable by applying very mechanically a couple of principles that I have learned on the TastyTrade platform. Tastytrade has a research team that provides very useful analysis presentations about options trading. Since I’ve started options trading, I have been applying a couple of principles very strictly to get the best possible results with my account size. By the way, the results of their research are shared publicly on their website and social media channels, open for everyone to consult, so there are no hidden secrets here. Their approach is based on statistics and probabilistic mathematics.

It is my aim to demonstrate and share the results I am having by applying these principles, while explaining my thought processes behind my trades. The important principles I will be applying for selling options in general are:

• Trade often : the more occurrences (trades) the closer the result will get the statistical expectation – this is basically the statistics law of large numbers, this means for me that its preferable to make many small trades instead of a few big ones because it brings me closer to the statistically expected result.

• Trade small : trading small doesn’t mean that I will be less profitable at all – trading small prevents that when a trade goes bad that my account will be set back hard. It means that the individual positions I am opening are small in relation to my account size (the margin requirement or the required buying power for new positions hardly ever are higher than 1% of my total account size).

• Trade out-of-the-money options (OTM) : the intrinsic value of an OTM option is zero and our goal is to let the option expire worthless or buy it back at a lower price then what we sold it for. As an option seller the passage of time works in our advantage, because the value of the option will erode by time decay (passage of time) because the less time the owner of the put option has to be right (to be ITM, for a put option = the share price below the strike price) the less valuable the option is.

• Trade High Probability of Profit options by good choice of the strike price : For almost all of my trades, I aim to sell options with a strike price at minimum one standard deviation (1SD) away from the share price. A strike price at 1SD gives me a 84% probability of the option staying OTM at expiration and thus a 84% probability of profit (PoP). I find this probability reasonably high enough to generate with high probability a profit if I make enough trades. By trading small, I will also limit the possible large loss if a trade would go awry (what also probabilistically will happen). This way the impact on the overall result of all trades is limited and under control especially if I make enough trades. It happens very often that I choose a strike price well above the 1SD-range too, to have a higher PoP. Options trading is always a game of risk and return (I don’t mind the lower return that comes with the lower risk, because as I stated before that I want to become highly profitable by trading often with high probability).

• Use of the optimal time decay period : we need to choose the optimal number of days to expiration (DTE). This number gives us the total number of days between trade initiation and trade expiration. Research shows that the optimal period for options to lose their value from a time decay perspective, is between 45 DTE to enter the trade and 21 DTE to leave the trade. So I mechanically try to enter trades around 45 DTE and decide to make decisions on the position at 21 DTE.

• Sell options with a high volatility rank : if you are new to options trading, the notion of “volatility” may be difficult to understand in the beginning, but that’s perfectly ok, don’t worry, I have been there too. You will get a good understanding quickly when you will study the other more in-depth articles on our site about it , but we won’t go too deep into this notion right here. Briefly, I can state that volatility is a measure of how much the value of a stock may fluctuate up and down. High (implied or expected) volatility of underlying stocks, will increase the option prices more because the expected price swings are larger. When selling options it is very preferable to sell options with a high Implied Volatility (the expected magnitude of future price fluctuations) because volatility will always tends to return to its mean (average), so it is obviously more profitable to sell an option when the IV is high (and option prices are more expensive) and buy the option back when the IV has gone lower or crushed (and option prices are less expensive). So when selecting a stock option, I basically look for stock with a high Implied Volatility Rank (IVR) which allows me to profit from the IV crush after selling the option, so I can close my position more profitable by buying the option back at a lower price. Options are like “insurance” contracts, and when the future of an asset becomes more uncertain, there is more demand for insurance what results in more expensive options. 

• Trade only in options with enough liquidity : high liquidity facilitates the ability to enter and, perhaps more importantly, to exit a trade at our choosing. We absolutely want to avoid that a winning trade become a losing trade simply because a lack of liquidity kept them from being able to close the position.

These are the best principles to become highly profitable, based on mathematics instead of gut feeling or based on market info.

As you probably have noticed, I frequently compare this way of trading with two other types of businesses: the insurance business and the casino-holder business. And the similarities are clearly there.

The insurance business because as an option seller, I am selling insurance over a specific time period to option buyers for a premium, predicting on a mathematical, probabilistically based model, that you won’t have to compensate an insurance claim. We sell And the analogy of being a casino-holder because you will get to the expected mathematical result by keeping the trades small but also by creating high occurrences, knowing that on average you will get closer and closer to the expected mathematical outcome.

6. Different ways to manage the selling puts strategy

As I have written above, the goal when selling a put option is to collect the premium and wait until the option expires worthless or to buy it back after the value of the put option has significantly decreased (dropped lower). Most of the time, I don’t have the intention to acquire the stock and consequently I don’t keep cash ready to buy the shares. This is what is called “selling or shorting naked (uncovered) puts”.

This drop in value of the option price, what I am waiting for, happens through 3 possible actions that may or may not happen simultaneously:

• a rise in the stock price
• passage of time
• a decline in the implied volatility level (IV)

The rules below are the basic managing rules I try to apply very mechanically to get a maximal optimal profitability when selling puts (these are mainly the managing principles I have learned from the Tastytrade Research platform):

• When during, the optimal time frame between 45 DTE till 21 DTE, the option trades at a 50% of Max profit, I will close the trade and buy back the option.

• When during, the optimal time frame between 45 DTE till 21 DTE, the share price drops to the level of the strike price and the strike price gets “tested” (that is how we call it), I will roll out the put option in time to a later expiration date for an extra credit. “Rolling out in time” actually means buying back the put option at the current expiration date and selling the put option (with the same strike price) at a later expiration date. I will always roll out for an extra credit (the option with the later expiration date will have more time-value included in the option price; and thus selling of the option with more time to expiration combined with buying back the option I initially had sold, results in an extra credit into my account). The extra credit gives me a lower break-even point.

• If the strike gets tested and I guess it is likely that the stock may drop even further, I can also roll out in time and adjust the strike price to a new lower strike price. I will normally only do this when I receive a credit. (I will hardly ever consider doing this for a debit).

• When during, the optimal time frame between 45 DTE till 21 DTE, the share price moves around but the strike price is NOT “tested”, I sit back and WAIT. I do this basically completely independent of market or stock news, I just let the strategy work. I trust the mechanics and the statistics behind the strategy!

• When the option arrives at 21 DTE I have two possibilities :
  • I can close with a profit, I will close the option at take the profit (even if it is small). Only for good reasons I sometimes keep the option open below 21 DTE (I will talk about the gamma risk when we go under the 21 DTE in another article).
  • I have a loss (meaning the option price is trading higher that the premium that I sold it for) and then I will manage my position by rolling the put option out in time for a extra credit, resulting basically in extra time to be right about the share price and I am lowering even the break-even point with the extra credit. And depending on the situation I will again roll out in time in combination with a strike adjustment.

7. Has this strategy produced great results?

Since I have started selling premium, shorting (or selling) naked puts has been one of my favourite option selling strategies.

Very often resulted a good selection of high IV stocks combined with rising stock prices, in a high profitability with profit taking at 50% of Max Profit even after a limited number of days.

In the last two months of 2020, I have closed 59 put option positions of which 53 where profitable, this is an overall 89,8% profitability of the put selling strategy.

The total profit of the these 59 closed positions is $4983.00 with the highest profit of $515 and the biggest loss of $110.

Take a look at my trade posts page to see our latest trades and at my trade result page to see the results we had up till this point. Both pages are created in full transparency.

This guide will be updated with more results of my put option selling trading in the months to come. In the mean while don’t hesitate to join the conversation, below in the comment section.

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Remark about the examples in this article: the examples using actual securities and price data, are strictly for illustrative and educational purposes only and are not to be construed as an endorsement or recommendation for these stocks as such. Please notice that also the examples used on this page do not include transaction costs (commissions, margin interest, fees) or tax implications, but they should be an element to consider prior to entering into a transactions as well for calculating your actual return on the investment.

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