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Short Put Option Strategy - Bullish Options Strategies - Bullish Options Strategies - YouTube
Channel: Option Alpha
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Hello everyone, and welcome back to optionalpha.com.
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This is Kirk, here again.
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And in this video, we're going to talk about
the short put option strategy.
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So as always, we'll get right into it here.
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So, we're going to first take a look at the
market outlook as we always do when we look
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at different option strategies here.
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Now, as you know, the naked put write is also
called a cash-secured put, in case you're
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writing it in an IRA or a retirement portfolio.
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But as a trader, you're really expecting a
steady rise of the stock price during the
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life of the option, and you consider the likelihood
of a decline very remote.
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Now, how conservative you get is something
that we'll talk about later on in this video
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tutorial.
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But think about option selling and particularly,
put option selling like selling stock insurance
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on a stock.
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The only real goal for writing an uncovered
put or selling a naked put is to earn the
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premium as income.
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So, I'll use the analogy that I always use,
and it's the analogy that was taught to me.
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It's like selling insurance on a house, right?
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If you own a house, or later on you might
own a house, you're going to buy insurance
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in case the house burns to the ground that
the insurance company is going to pay big
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time to help you rebuild that house.
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Now, for that protection, you're going to
pay the insurance company a premium every
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single year.
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And if your house never burns to the ground,
then the insurance company keeps that premium,
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right?
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That's their income for the protection that
they're giving you.
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Well, selling a put is just like that for
a house, right?
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You sell insurance on a stock.
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You protect investors from the strike price
all the way to zero.
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And for that risk, you take on some sort of
premium as income.
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So, how do we set this up?
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These are very easy to setup actually.
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It's just a single leg option.
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So, you simply go into your broker platform
and you initiate an order to sell a put to
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open, you sell it right at the strike price
and the expiration period that you desire.
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So, you can sell these front month, meaning
the next expiration period.
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You can sell them close to the market, far
away from the market.
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Obviously, the closer you get in expiration
period and the further away you get, then
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it will change the premium that you receive
because it changes the risk reward profile
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of the option strategy.
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So, like I said here, the more conservative
you are, the further out of the money you
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can sell the put option.
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So, what's the risk with this particular option
strategy?
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While the maximum theoretical loss is limited,
but it's very substantial.
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So in theory, there is a limited loss.
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The worst that can happen is for the stock
price to fall all the way to zero.
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In this case, the investor would be obligated
to buy a worthless stock at a strike price.
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So again, when we talk about option selling,
we are actually on the obligation end of an
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option.
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So, if you're an option buyer, then you have
a choice, you have an option.
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If you're an option seller, (whether it's
a call or a put) you're on the obligation
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end, and it's up to the other party if they
want you to exercise that obligation.
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So, if the stock were to fall all the way
to zero, then we'd still be obligated to buy
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the stock at the 45 strike price which is
where the option actually pivots in my particular
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chart here.
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So, we'd be buying a stock that's worthless
at $45 a share.
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You can see this is a very real threat for
individual stocks, right?
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Individual stocks overnight, can gap lower.
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Do I dare even mention Netflix, Bear Stearns,
Lehman Brothers, etc.
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It is a very real risk.
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But not so much for indexes and commodities
which is why I tend to favor these on those,
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because the S&P 500 index can never really
go to zero.
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It's made up of 500 individual stocks, so
all 500 stocks would have to go to zero.
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Commodities really could never go to zero,
right?
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They have some value in the marketplace like
oil and gold and silver.
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The profit potential (like we talked about
earlier) is just the premium that you took
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in during the sale of the put option, right?
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So, just like an insurance company that gives
you a policy to protect your house against
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fire, you are only going to give them that
premium for the entire year.
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They don't ask for any more money if you negotiate
a single premium.
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So, just like that with option selling and
put selling, the maximum gain is the premium
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you took in.
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So, the best case scenario is for the stock
price to be anywhere above the strike price
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at expiration.
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In that case, the option expires worthless
and you never have to do anything to close
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the trade.
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You just keep that money.
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And that's where some commission savings really
come into play.
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So, when we talk about volatility, we are
short in options.
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So generally speaking, an increase in volatility
would have a negative impact on this strategy,
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everything else being equal.
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Again, remember that volatility tends to boost
the value of options, and since we want the
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value of our option to go to zero by expiration,
a big move in volatility can be harmful because
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then, the stock can swing in bigger chunks
and can swing outside of our profit target,
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right?
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So, we want low volatility, minimal movement
in the underlying security or stock.
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Remember that at the money options will have
different volatility characteristics and will
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behave much differently than out of the money.
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If you sell an option right next to the market
and right at the money, then that will behave
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completely different than if you sell an option
that say $20 or $30 away from the market.
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When we get into time decay, time decay is
actually one of our strongest assets when
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we're talking about put selling.
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So, the passage of time is really what creates
the opportunity for the strategy and is therefore,
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very positive for short puts.
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Remember that we want the option to expire
worthless, so every day that passes and we
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can get some really good time decay on these
strategies, is money in our pocket.
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So, the closer we get to expiration without
the stock moving beyond the strike price,
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the better.
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As expiration approaches, the option move
towards its intrinsic value.
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So, as it becomes an out of the money put,
that intrinsic value is zero.
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So, if we never have to pay any money on our
insurance contract, (again, going back to
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our insurance analogy) then we get to keep
all that money.
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So, every day that we get closer to the expiration
day of that insurance contract is better for
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us.
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When we talk about breakeven points, (again,
this is very easy to calculate with this particular
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strategy) it breaks even if the stock price
is equal to the strike price minus the initial
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put received.
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Anything above this level at expiration is
in towards your maximum profit.
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So again, let's say we have a 45 strike put
here that we sold.
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So, we take the strike price, we subtract
the premium that we received, and that is
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our breakeven price, right?
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So, we got the premium, and so, we have to
move that down the scale to see where our
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breakeven price is.
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Again, very easy to calculate with short puts.
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Let's look at an example just to really drive
home the point.
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So, we have a stock price that's trading at
50 right here on our chart.
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We're going to sell one 45 put and take in
a credit or a premium of $200.
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Now, just quickly, let's flip this around
and say we were going to buy this 45 put option.
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We'd be outlaying that $200 to buy the option.
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But since we're on the other end of the trade,
we're selling that option for a $200 credit.
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Immediately, that comes right to your account.
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So, you get a $200 credit.
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Now, the maximum loss again, is practically
unlimited to the downside.
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Again, if you choose a stock that's highly
volatile and it just absolutely falls to pieces,
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then you do have a huge loss.
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Now, if you do this on an index, (for example)
then your losses are much, much more capped
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in theory because they're not going to go
to the downside.
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An index can never close all the way down
at zero.
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It's made up of securities.
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Same thing with commodities like gold, oil,
silver.
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Your maximum profit again is your $200.
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So again, it's just the premium that you took
in.
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So, if you took in $500, your maximum profit
would be $500, whatever the case is.
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Now, you can actually buy this back later
on during the cycle.
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You can buy another option back and create
some sort of profit.
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So, let's say that you actually sold it for
$200, and further on down the road, you actually
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see that this has decayed down to a value
of $100.
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So, you could go back in and buy one 45 strike
put, (again, reversing your trade) whereas
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you are short one put option, you now want
to become even or neutral, so you create a
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reversing order and buy that put back, and
you pay $100.
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Because remember, the value right now is $100.
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So, you're going to sell it at $200 and buy
back later at $100.
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Again, this is a good opportunity to close
out the trade early and take in some really
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good gains.
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Some of my tips and tricks regarding put selling
and naked put selling.
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Short puts are really the bread-and-butter
of my personal options trading plan, and have
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been for years, and literally years when I
talk about this, six to seven years now.
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They sound really dangerous on the outside,
but in reality, option buying is much, much
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more dangerous.
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So, what I do is I sell deep out of the money
puts.
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I sell puts that are very far from the market,
20%, 30% away with historical probabilities
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of expiring worthless between 90% and 95%.
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And you can actually get these percentages
right on your broker platform.
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I avoid selling close to the market.
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Again, the closer I get to the market, I do
get more premium, but it also becomes more
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risky.
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And if done properly, put selling can be a
non-directional strategy for monthly income.
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Again, I've been doing it for years.
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You can check my performance.
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I'm 100% open and honest with all the trading
that I do here on the website and this is
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my bread-and-butter strategy.
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And it is one of the basic building blocks
of other strategies that I'll talk about in
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different videos.
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So as always, I hope you guys really enjoyed
this video.
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And thanks for watching!
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