Navigating the World of Put Writing: Strategies, Benefits, and More

In the realm of trading strategies, ‘Put Writing’ stands out as a potent technique that grants traders the power to earn money or acquire their favorite stocks at a discounted rate.

Picture possessing a hidden tool that enhances your trading prowess – that’s precisely what put writing brings to the table. While it may initially appear intricate, fret not; grasping its nuances can prove immensely rewarding.

This introductory guide will navigate you through the essentials of put writing, unraveling its intricacies and showcasing how it can seamlessly integrate into your trading blueprint.

Also Read | Understanding Protective Put Strategies in Options Trading

What Is Put Writing?

Put writing means selling a put option, a financial contract that gives the buyer the right but not the obligation to sell an asset at a predetermined price before expiration.

In put writing, an investor, known as the writer, receives a premium from the option buyer. If the asset’s price stays above the predetermined price (strike price), the put option expires worthless, and the writer keeps the premium as profit.

However, if the asset’s price falls below the strike price, the writer might need to buy the asset at the higher strike price.

Difference Between Call and Put options

Call and put options are financial contracts that provide investors with the right but not the obligation to buy (call option) or sell (put option) an asset at a predetermined price before expiration.

Call writing meaning: Call writing involves selling call options. The writer receives a premium from the buyer. If the asset’s price remains below the strike price, the call option expires worthless, and the writer keeps the premium.

If the asset’s price exceeds the strike price, the option buyer might exercise the option, and the writer must sell the asset at the lower strike price.

Put Writing for Income

A widely practiced strategy known as “put writing” emerges as a favorite among astute traders. This tactical approach involves the art of selling a contract, referred to as a put option. Here, assuming the mantle of the put seller or writer, you willingly commit to acquiring a predetermined quantity of stock at an agreed-upon price termed the “strike price,” all within a specified timeframe.

Consider a scenario where your watchful eye is on a stock presently valued at Rs 1,000 per share. Assuming the role of the put writer, you opt to sell a put option with a strike price fixed at Rs 950, amassing an upfront premium of Rs 50 per share. As long as the stock’s price remains aloft of the Rs 950 benchmark until the option’s culmination, the potential for the option holder to exercise their rights is obviated. Consequently, the Rs 50 premium securely rests in your possession as a gratifying profit.

Yet, an air of caution is indispensable. Should the stock’s value plunge beneath the Rs 950 threshold, the purchaser of the option reserves the privilege to enact their prerogative. Herein lies your commitment, as the put writer, to procure the stock at the stipulated strike price, irrespective of its diminished market valuation.

As the risk intrinsic to writing looms, shrewd strategic decision-making, an acutely attuned comprehension of market oscillations, and the income derived from amassed premiums collectively contribute to a balancing act.

Benefits of Put Writing

This strategy offers several benefits to investors who are looking to capitalize on specific market scenarios while managing risk. Here are some of the key benefits of put writing:

• Income Generation: Put writing allows investors to earn premiums by selling put options. These premiums serve as immediate income, regardless of whether the option is eventually exercised or not.
• Lower Entry Costs: Investors can use put writing to potentially acquire assets at a reduced cost basis. If the put option is exercised, they buy the asset at the strike price, which could be lower than the current market price.
• Profit in Sideways Markets: Put writing can lead to profits even in markets that are relatively stagnant or mildly bullish, as long as the options expire out of the money and the premiums are retained.
• Portfolio Hedging: Put writing can act as a form of portfolio insurance. By selling put options on existing holdings, investors can partially offset potential losses in the event of a market downturn.
• Flexibility and Strategy: Put writing strategies offer flexibility in adjusting strike prices and expiration dates. This adaptability allows investors to tailor their positions to market conditions and their own risk tolerance.

Steps to Execute Put Writing

Executing put writing involves selling put options with the intention of generating income from the premiums received. This strategy is often used by investors who are neutral to slightly bullish on the underlying asset. Here are the steps to execute put writing:

Step 1: Choose the Underlying Asset:

First off, opt for an underlying asset you’d be at ease owning at a reduced cost. This could be anything from a stock or an index to a commodity. Make sure options are available for trading on this asset.

Step 2: Determine the Strike Price and Expiration Date:

Next, identify the strike price, which is the rate at which you’re willing to acquire the underlying asset if the option is exercised. This strike price significantly influences the premium you’ll rake in. Additionally, select an expiration date for your option contract, setting the lifespan of the option.

Step 3: Analyze Market Conditions:

Evaluate the market conditions and the outlook for the underlying asset. Put writing is most effective in neutral or mildly bullish markets where you believe the asset’s price is likely to remain stable or rise slightly.

Step 4: Calculate Potential Returns and Risks:

Use options pricing models or trading platforms to estimate the potential premium you could receive for selling the put option. Compare this premium to the strike price to determine the potential return on investment. Also, assess the potential risks, including the possibility of having to buy the underlying asset at the strike price if the option is exercised.

Step 5: Sell the Put Option:

Place an order to sell the put option through your broker. You’ll receive a premium upfront from the buyer of the put option. This premium is yours to keep regardless of whether the option is exercised or not.

Step 6: Monitor the Trade:

It’s crucial to monitor both the underlying asset and your option regularly. If the market price of your asset stays above the strike price and the option expires worthless, you get to keep the premium as your gain. On the flip side, if the market price tumbles below the strike price, you might be obligated to buy the assets at that rate.

Step 7: Manage Exercised Options:

Should the market price dip under the strike price and your put option gets exercised, be prepared to buy the underlying asset at the settled strike price. At this juncture, you have two choices: hold onto the asset and possibly benefit from its eventual recovery or sell it instantly if you no longer wish to own it.

Wrapping Up

Put writing is a savvy approach to generate income in the stock market. It revolves around selling a unique contract known as a put option. While it can serve as a steady income source and even lessen the expense of stock acquisition, it’s not devoid of risks.

These risks could include heavy losses if the market turns against you. Hence, it’s vital to be well-informed, exercise caution, and perhaps seek professional advice before venturing into this financial strategy.

Also Read | Call and Put Option Trading: How to Get Started on it