A Millennial Selling Puts for Income

11 Things to Know about Selling Puts for Income (Safely)

Are you thinking of selling put options for income? If so, you came to the right place. Of course, if you landed here by accident, this article is sure to change your view.

In case you read my book, you’ll know I retired as a millionaire at age 35, despite having dropped out of high school, and even went through a bankruptcy! Following many, many mistakes, I learned how to get myself out of the hole I kept digging. And today, I am financially independent

My last article, Selling Covered Calls to Generate Monthly Income, discusses a safe way to generate income on equities you already own. But, what if you wanted to generate monthly income from equities you don’t already own?

Indeed, one of my favorite trades is selling put options to generate monthly income from a portfolio (option premium). Selling puts on quality stocks, and ETF’s (which I will now refer to as equity/equities) I would be happy to buy is one way to earn guaranteed income.

What is a put option?

First, it’s essential to know what a put option is. A put option is a contract where the put seller must buy an item from the put buyer, at a specific price before the contract expires.  And, you guessed it! You want to be selling puts.

For example, let’s take Jimmy, Sally, and a pound of beans.

Today, beans cost $10 a pound.

Sally has a truck full of beans and is worried the price of beans will go down. Further, Sally wants to protect her financial investment in beans.  

On the other hand, Jimmy thinks the price of beans will be about the same or higher next month. 

Jimmy approaches Sally to buy a pound of beans from her for $10, if she wishes, at any point until the contract expires. The cost of this contract would be $1. Both agree, and Sally pays Jimmy the $1 fee for this contract. The $1 is the income (option premium) that Jimmy gets to keep, no matter how much the beans go up or down in value.

Fast forward next month…

Fast forward next month, and a pound of beans now cost $9. Sally can now sell a pound of beans to Jimmy for the contracted rate of $10.  

Remember, this contract says Jimmy must buy a pound of beans from Sally for $10 if she requests it before the contract expires. Indeed, this is true even if the price of beans goes to $0. 

What if beans cost more than $10 a pound?

On the other hand, what if a pound of beans now cost more than $10? In this case, Sally’s option contract is worthless, but her investment in beans is secure. Regardless, Jimmy gets to keep his income (option premium), and Sally keeps her beans.  

Who would you rather be? Jimmy, or Sally?

All options have rights and obligations. For example, those who buy put options have the right to sell the underlying equity to the buyer at any point before the contract expires. In exchange, the option buyer pays the seller an option premium (income). And, this premium is guaranteed income that the seller gets to keep. Best yet, you can repeat the trade, again and again, week after week, month after month.  

Things to know about selling puts to generate income

Like any investment, you’ll need to know some basic things about it.

What do I need to sell put options

To sell put options and generate monthly income, you will need to have collateral in the form of cash or margin in your brokerage account. Remember, the put option seller agrees to buy equities in the future, so, your brokerage needs to have an ample amount of collateral to ensure you can afford the purchase. 

For example, if you want to sell 1 put option on the SPY, you’ll need to be able to buy 100 shares of the SPY in your brokerage account. Conversely, if you want to sell 5 put options (and earn 5x the money), you’ll need to have enough cash or margin available to purchase 500 shares of the SPY in your brokerage account.

Strike price

The strike price is the contracted price that you, the put seller will buy the equity at (stock, or ETF), should the equity be below the strike price at expiration. In Jimmy and Sally’s example, $10 is the strike price.

Expiration date

The expiration date is the last date the buyer can purchase the equity (called exercising) from you. Generally, options expire on the 3rd Friday of each month. However, some options expire weekly (on Fridays), and some expire on Mondays, Wednesdays, and Fridays.

How does selling put options work?

First, for each put option you want to sell, you will need to be able to buy 100 shares of the underlying equity. For example, if you’re going to sell 2 put options on the SPY, you’ll need to have enough collateral or margin to buy 200 shares of the SPY already in your brokerage account.  

Second, you will need to determine the strike price to sell the put option. In general, I like to put sell options slightly “At the money” or slightly “Out of the money.” An “At the money” put option means the underlying equity and put option strike price is essentially the same. By contrast, an “Out of the money” put option means the strike price is lower than the underlying equity.  

Examples of “At the Money” and “Out of the Money” put options

Today, the SPY is currently trading at $316.58.

A strike price “At the Money” would be $316.

Conversely, an “Out of the Money” strike price would be $315 or higher.

Last, there’s also another type called “In the Money.” Using the same SPY ETF above, an “In the Money” put option is one that has a strike price of $317 or more. 

How much can you make selling puts?

In general, you can earn anywhere between 1 and 5% (or more) selling puts, it all depends on your trading strategy. How much you earn depends on how volatile the stock market currently is, the strike price, and the expiration date. In general, the more unstable the markets are, the higher the monthly income you’ll earn from selling puts. Conversely, when the markets are calmer, you’ll have to start selling puts with a further expiration date to get a higher return.

I prefer selling puts slightly “Out of the Money,” with an expiration of 3-6 weeks out. Indeed, this strategy gives me the most amount of income upfront. 

What are the risks in selling put options?

a diagram showing risks vs rewards selling puts

First, you must remember that by selling puts, you agree to buy the underlying equity should the put buyer wish, at any point, until expiration.

The risk in selling puts is that you might end up buying equity for less than its worth. Indeed, you need to be sure that whatever you are selling a put on, that it is a quality stock or ETF that you would be happy to own today, at the agreed strike price. Sure, once you own it, you can do whatever you like. For example, you can keep it, or generate additional income by selling covered calls on it!

For example, today, the SPY is trading at $316.58. You decide to sell a put option with a strike of $316 that expires July 17, 2020, and collect $4 of income (option premium). Then, at expiration, let’s say the SPY is trading at $315. In this case, you’ll have to buy 100 shares of SPY for $316. But, don’t forget, you’ll already have collected $4 (times 100) for the put option itself! So no matter, in this case, you still made a profit. 

Regardless, it’s essential to be clear on your rights and obligations of selling puts. Namely, if you get exercised, you’ll have to buy 100 Shares X the number of put contracts you’ve sold of the underlying equity.

Examples of selling put options for income

Let’s consider an example of selling put options to generate income.

As of today, July 6, 2020, the SPY is trading at $316.58. The $316 put option expiring July 17, 2020, is currently being trading for $4.00.  

What does this mean? If you sell one SPY put at a $316 strike with an expiration of July 17, 2020, you will generate $400 in income that’s yours to keep! Best yet, if you want more guaranteed income, sell more than one contract. But remember, you must be able to buy 100 shares X the number of put option contracts you sell.

Let’s examine the following scenario (#1)

NYSE Stock exchange floor

Today, July 6, 2020, the SPY Trades at $316.58

Then, you sell 1 put contract, out of the money ($316 strike) that expires July 17, 2020. Then, you get to collect $400 of income.

You need to be able to buy 100 shares of the SPY at the strike price (Total $31600.00)

Income Collected

Right off the bat, you’ve earned $400 by selling the put option. Indeed, that’s the option premium (income) you get to keep. Moreover, it lowers your cost to buy the SPY by $400, should the contract gets exercised.

On July 17, 2020, if the SPY trades at $315, your contract will be exercised. Yes, you’ll have to buy 100 X SPY shares for $316. Is this bad? Well, consider that you collected $4.00 in income per share ($400 total). So, yes, you’ve lost a little on the purchase, but the income (option premium) is yours to keep!

Crunching the numbers

Consider that the SPY is $315.00 on July 17, 2020. And, you bought your SPY equity for $316. In this case, you’ll have a loss of $100 ( $1 times 100) on the SPY. However, you still keep your $400, for a total profit of $300. Not bad!

Put selling scenario #2

Using the same SPY from scenario #1, today, the SPY trades for $316.58. You sell 1 put option contract, out of the money ($310 strike) that expires July 17, 2020, for $2. You’ll need enough collateral to be able to buy 100 shares of the SPY for a total outlay of $31000.00, should the contract be exercised.

And like before, you’ve earned $208 from selling the put option. Indeed, that’s the put option income you get to keep. Also, don’t forget, it lowers your cost to buy the SPY by $200, should you be exercised.

Then, on July 17, 2020, if the SPY trades at $315. Note that this is higher than the strike price on your put option. Your put option contract expires worthless, you don’t need to buy any shares, and you get to keep your income.

Crunching the numbers

You sold an out of the money put option and received $200 of income (Option Premium).

Then, on July 17, 2020, the SPY is now trading for $315. You get to keep all your money and don’t need to purchase any shares.

Considering over the past 90 years, the annualized rate of return of the S&P 500 is 9.8%, I think this example of selling puts is a clear winner!

But, here’s where it gets even more interesting. When selling puts, don’t forget that at expiration, you can just sell another put option for the next month, and that income is also yours to keep. Rinse and repeat!

Effects of Taxation on Selling Put Options

someone collecting infoformation for their taxes from selling puts

In the United States, options premiums are considered short term gains. A short term gain is a profit earned by holding property for less than a year. Also, the gain is taxed as ordinary income. By contrast, in Canada, it’s generally considered a capital gain.

Is selling put options for income profitable?

Selling put options is a guaranteed way to earn income, and yes, it can be very profitable, month after month. The key is to remember to sell put options on only high-quality equities or ETF’s that you would want to own. My favorite equities to put options on are the SPY (SPDR S&P500 ETF), and large, quality companies such as Apple and Google. Indeed, over the long term, these are high-quality companies whose stock prices generally move upwards.

However, you should have a plan B in case you get exercised, and forced to buy the underlying equity at a loss. In the SPY scenario above, if it dropped to $310 at the time of expiration, and you had to buy it at $315, what could you do? Well, you could write a covered call option for income!

Selling Weekly Put Options for Income

Generally, options expire on the 3rd Friday of each month. However, many stocks and ETF’s now offer a wider range of expiration dates. For example, the SPY has options that expire on Mondays, Wednesdays, and Fridays of each week! In other words, you could start selling weekly puts for income, as much as three times a week, every week! To be sure, considering the short time duration, it’s important to note that the premium income generated from selling weekly puts (less than a week out) might not be “exciting”.

Can you lose money selling puts?

You will never lose the income from selling puts. To be sure, the income you receive from selling puts is guaranteed. However, if you get exercised, AND you sell the equity at a loss, then yes, that might incur a loss. For example, let us say you sold a $316 put on the SPY. It expires July 17, 2020, and you collect $400 ($4 a share). Then, on July 17, 2020, the SPY is trading for $300. In this case, you’ll have to buy 100 shares of the SPY at $316, even though they are worth only $300. That would be a $1,200 loss if you sold your SPY shares.  

So, just like having a home budget where you track your income and expenses, it’s essential to keep track of your profits and losses from selling puts. Starting today, you can watch my own P&L after the trades have completed.

Frequently Asked Questions (FAQ)

Are put options bad?

The only thing that is bad about selling put options for income is that you may lose money if the underlying equity dips below the strike price. However, you do collect the income as a result. For this reason, when selling puts, its always a good idea to have your plan B. For example, if you get assigned, you can always start selling covered calls!

How do you start selling puts for income?

At a minimum, you will need a brokerage account, with options trading (You might need to let the brokerage know you want to be selling puts).

Should you be selling puts?

Anyone seeking additional income from their portfolio can consider selling puts.

What is selling naked puts?

Selling naked puts involves selling an option on an equity or ETF that you don’t already own. Rather, you’re using the cash and/or margin in your brokerage account as the security.

What is a poor man’s put?

A poor man’s put is also known as a credit spread. In this case, the “poor man” either don’t have the funds to purchase the 100 shares of the equity, should he be exercised. In this case, the “poor man” sells a put option and then buys one at a strike price slightly further out of the money (for less than the put he sold). The “poor man” gets to keep the difference, known as the credit. The risk is the difference between the strike prices. A credit spread (or poor man’s put) offers less downside risk, requires less money upfront, but the reward is less. Also, selling credit spreads will be for another article.

What happens when you sell a put?

As soon as you sell your put, the income (option premium) gets deposited into your brokerage account. Generally speaking, you can do whatever you want with it.

Is selling put options safe?

Financial experts agree that selling puts is about as risky as owning the equity outright. It’s safer because the income (option premium) lowers the cost of the equity should the contract be exercised. However, you must be ready to buy the underlying equity should the contract be exercised.

What about selling weekly put options?

You can sell weekly puts, however, just be aware that you will collect more income, the further into the future you sell the put.

What are the best stocks for selling put options?

In my opinion, selling puts on high-quality stocks, and index ETFs that you would be happy to own can give you the best consistent return.

What is the Best Trading Strategy for Selling Puts To Generate Income

The aim of this website isn’t to provide investment advice; instead, it gives you the tools and knowledge to start selling puts.

Conclusion

Selling puts can be an excellent way to generate monthly income. To be sure, any investment incurs risk. And, I feel that the income received by selling a put helps offset any overall risk.

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