The Options Trading Academy

Howto reduce your lost and increase your earnings while building your portfolio using options trading

This time we address the one of the basic positions in options trading. The sold put. A sale of a PUT contract is an obligation to buy an asset (underlying) on the specified date (maturity) at a fixed price (strike).

When we sell a put, we receive a premium for the purchase of the underlying obligation. If the strike that we do is 6 points; the benefit of the premium is 2 points, our break even is at four points. From this level, we incur in loses on the same proportion as do the underlying. When the underlying at maturity is above the strike, our benefits are fixed and correspond to the price of the premium. As in all cases, there is no actual sale, but a forced sale at a given date.

What do we expect the market where we sell a put?

As all positions sold expect a decrease in volatility and/or in this case… a bull market.

Either of these two facts can be beneficial to this position because, although the market was bearish and volatility is not high, to a lesser extend, we will benefit.

Consider the sensitivity of the option premium to extrinsic factors.

The DELTA in these options is positive, given the increases in the price of the underlying to the position. The more ITM options are, greater intrinsic value, so that the probability of exercise is high damaging the position. As the delta value decreases away from the strike (upward) which favors the put sold.

The GAMMA of a sold put is negative, as we know the gamma of the option indicates the variation of the delta to raise the price of the underlying. As the option is sold, the underlying rise does not affect us to a rise in the price of the option (our greatest benefit is in the premium). So remember that the gamma of the options sold – both puts and calls – is always negative.

The THETA of these options is positive. The passage of time supports the position of options written, the time value decreases as the options approach expiration.

The VEGA showed us the implied volatility of the market if it’s a busy market price variability or if the contrary, is a less aggressive market. Obviously for the options sold, increased volatility hurt positions because we4 have an obligation to fulfill, so the Vega sold the put is negative )as was the case of the sold call)

the RHO also have a negative sign. The Rho is always negative for options to sell (put) because we do not assume that we can take advantage of a payment for interest rates. But this is hardly a factor affecting the price of the premium, and even more the level of rates that we are today.

SELLING A PUT

In this case we bet on the market to be volatile, but lacking on any case with an upward trend. As mentioned above, either of these circumstances is favorable to the seller of put options. Lets peek into the market to take a look at our interest to sell.

Faced with a low volatility on the market we bet for a close expiration, since the risk with an increasing volatility also grow in time.

Every financial market have discounts throughout the year that are not “bargains”. Lets the fun begin.

Lets say you want a stock portfolio with several titles… including Dell stocks for example, because you feel the market will move higher in coming months.

Instead of going to the market and buy directly the stocks, you have decided first to see the range of positions of puts for individual values. For the year-end expiration (4 months let’s say) these are the various strikes. Call now quoting at $11.58 bucks. If we were selling Dell put on strike and maturity 11.50,forcing us to sell at that price; which means below that strike price before the end we will have to buy the stocks… which is what we want after all. The number of stocks we want is 2000 which represents an investment in the spot market of 23160 bucks. If we choose the strike that note,we would get the amount of US$ 0.53*2000 = 1120 dollars; which represents 4.8% of the investment.

You see… if Dell were quoting at maturity below the established $11.50 strike (forcing us to sell) we will have to buy the stock, which was our desire in the first place; but we pocketed a bonus of nearly 5% which is the “rebate”. In the event that at maturity, the price is higher than $11.50 there is no obligation of buying the shares and the put we sold will have no implicit value; would become extinct and we benefit from  the 5% of the premium. In this last case we could start again the operation of “buying with discount” with a new sold put until we buy the stocks that we intent to.

Let’s see what would happen if you actually quoted at $10.50

May occur:

1. Since we had been forced to sell Dell stock to $11.50 (strike), obviously we must buy as the buyer of the put (in a position contrary to ours) will exercise his right on a fairly implied value option. So we bought 2000 shares of which will call the buyer of the option. Our result will be $10.50 – $11.50 * 2000 = – $2000 dollars; Payment of the premium of $1120. Total lost of US $880 equivalent to % 3.82. Meanwhile, the price of Dell shares fallen by 9.33% (from $11.58 to $10.50), which we have benefited from an almost 5%.
2. A more appropriate possibility would be to buy the put option that we had sold the day of maturity, extrinsic value is virtually none and close the position. Our loss would be approximately the same as in the previous case and we could buy the shares or start a new sale of puts. This will be repeated in any asset of the portfolio we want to build.