Is Selling Put Options Safe or Risky? (The SHOCKING Truth…)

So is selling Put options actually safe or risky?

On one hand, you have people saying things like:

I make thousands of dollars each month selling Put options!

If you want consistent income you should be selling Put options!

You can get rich by selling Put options!

But on the other hand, you have people who got burned by selling Put options and saying things like:

I got a margin call and blew up my account selling Put options!

I lost all my money because I sold Put options!

Selling Put Options is extremely risky. NEVER sell Put options!

So what is the truth?

Is selling Put options actually safe?

Or is it downright risky?

Let’s find out.

Buying Shares Versus Selling Put Options

In order to really understand whether Put options is safe or risky, the first thing we need to do is compare it to the alternative.

And what’s the alternative?

It is to buy shares.

Let’s compare the two to see which is riskier.

The above image is the chart of Amazon (Ticker: AMZN).

It is currently trading at $113.55.

Let’s assume that we want to get AMZN at $100.

To compare buying shares to selling Put options, we will do a simulation for both.

That means we will simulate buying 100 shares at $100, and selling a Put option with the strike price of 100.

And let’s say for selling the Put option, we can receive a credit of $2.50.

That means we receive $250 in premium for selling the Put option since each option contract controls 100 shares.

Now, let’s assume that AMZN goes down to $80.

So both the 100 shares and Short Put will be in a loss.

The question is, how much does the 100 shares lose?

And how much does the Short Put lose?

Let’s take a look at both the risk profiles to find out.

On the left hand side is the risk profile of the 100 shares.

You can see that if AMZN drops to $80, the 100 shares would lose $2,000.

That’s because if you bought 100 shares at $100 and you were to lose $20 per share, then 100 shares would be a total loss of $2,000.

On the right hand side is the risk profile of the Short Put.

If you noticed, there are two different colored lines.

The light blue line is the profit & loss at expiration.

The purple line is the profit & loss on the current day.

Over time, the purple line will converge with the blue line.

That’s because as it gets closer to the expiration date, the extrinsic value from the Short Put will gradually decay to zero.

So at the $80 mark, the purple line shows a loss of $1740.23.

And the light blue line shows a loss of $1827.79.

In both cases, the losses are lesser than the loss of buying 100 shares!

Why is that so?

That is because you’ve already collected $250 for selling the Put option.

This premium helps offset some of the losses as AMZN goes down.

Now, what if the worst-case scenario happens?

That means AMZN goes to $0.

How much does buying 100 shares lose?

And how much does the Short Put lose?

As you can see in the risk profile above, if AMZN goes to $0, then 100 shares would lose you $10,000.

But for the Short Put, you would lose $9,750.

As you can, the Short Put always loses lesser than the alternative of buying 100 shares.

So here’s the important thing to understand…

Selling Put options have a very similar risk profile to buying 100 shares.

In fact, you lose less selling Puts.

That means, selling Put options is actually less riskier than buying shares!

If that’s the case, then why are there still many people saying that selling Put options are much risker than buying shares?

And why are there many people getting margin calls and blowing up their account selling Put options?

The Real Reason Why People Get Burned Selling Put Options

The real reason why many people lose a lot of money and blow up their account selling Put options is because of the number in the red box below:

The number in the red box is basically the margin you need to put up for selling one Put option.

You see, if you’re exercised on the Put option at the 100 strike price, it means you’d have to put up $10,000 to buy 100 shares of the underlying stock.

But your broker does not need you to put up $10,000 to sell the Put option.

Instead, your broker only needs you to put up around a $1,000 in margin to sell the Put option!

That’s a leverage of 10:1.

That means with just $1,000 you get to control $10,000 worth of shares!

And by putting up this $1,000, you’re able to get $250 in premium.

That’s a whopping 25% return!

So, many beginner option traders see that they can make so much just for putting up so little in margin, they try to max out the number of Put options they can sell based on this margin.

For example, if their account size is $5,000, they would sell 5 Put options to receive a total premium of $1,250.

But what they do not realize is that they are taking on more risk than their account can handle.

The number that they should instead be concerned about is the “Max Loss” number.

The “Max Loss” number shows $9,750.

So with 5 Short Put options, the max loss is $48,750!

But their account size is only $5,000.

Can you see why many people easily blow up their accounts?

That’s because it only takes a relatively small drop in AMZN for their account to get wiped out.

Let’s take a look at exactly how much AMZN needs to move down in order for their $5,000 account to be wiped out.

As you can see in the risk profile above, if AMZN were to drop to $90.84, the loss would be $5,003.87.

That means the $5,000 account would be wiped out.

That’s less than a 10% move from $100.

And AMZN can easily move 10% up or down in a year.

So by selling 5 Put options, they put themselves in a “huge risk huge reward” situation.

If AMZN goes up, they think that they’re a genius and that they can easily get rich selling Put options.

But if AMZN goes down, they think that selling Put options is downright risky and dangerous.

Hence, the huge polarity in opinion about selling Put options.

In fact, one of my friends went through this drastic polarity in his opinion of selling Put options.

When Alibaba (Ticker: BABA) was trading at $173.73 sometime ago, he sold 6 Put options at the 160 strike price for $5.00 a piece.

So for 6 Put options, he received a total premium of $3,000.

If he were to get exercised on the 6 Put options, he would need to put up a capital of $96,000 to buy the shares.

The problem was that his account size was only $25,000.

And he already had many other positions in his account.

But he came to me telling me that it was “easy money” selling Put options.

And I told him that it’s only considered “easy money” if BABA expired worthless.

His response was that there’s no way BABA would go below $160 since it’s already severely oversold.

Not too long after, BABA went as low as around $75.

He came back to me in desperation asking for help on what to do.

So I told him that he’d have to either top up more money into his account, or he’d have to take a loss on some of his positions.

Long story short, after this incident, he’s now afraid of selling Put options again.

Risky Versus Calculated Risk

You see, one thing to understand is that you can’t avoid risk when you’re putting money in the stock market.

As long as you’re putting money on the line, there’s always risk.

However, there’s a difference between the term “risky” and “calculated risk”.

In my opinion, a trade is only considered “risky” if you do not have a plan on what to do if the trade goes against you.

For example, the people that get burned selling Put options usually have the following mindset:

• They don’t think of the possibility that the trade can go against them.
• They only think of how much money they can make while ignoring the maximum possible loss.
• They didn’t plan for the worst-case scenario.
• They don’t really understand the strategy and don’t have a plan for different scenarios that can happen.

On the other hand, people who understand risk conceptualize it as “calculated risk”.

These are the people with the following mindset:

• They understand that there is a possibility of the trade going against them.
• They don’t just think of how much money they can make, but also consider the max loss on the trade and position size their trade accordingly.
• They plan for the worst-case scenario so that if it happens, they know exactly what to do and aren’t surprised.
• They thoroughly understand the strategy and fully accept the risk involved.

So instead of thinking whether a certain option strategy is “risky” or not, try and fully understand the strategy first and take a “calculated risk” approach.

How To Make Selling Put Options “Safer”

Now that we understand the concept of “risky” versus “calculated risk”, let’s take the latter approach and see how we can make selling Put options safer.

So here are a few methods to make selling Put options safer for you.

1. Plan For The Worst-Case Scenario

The first method to make selling Put options safer is to ensure you know the maximum risk in the worst-case scenario.

If you know the maximum amount that you can possibly lose, you’d be able to prepare for it.

2. Have Enough Funds

The second method is to ensure that you have enough funds to fulfil the obligations of buying 100 shares of the underlying stock if you get assigned on your Put options.

For example, if you sold 2 Put options at the strike price of 10, that means you’d need a capital of $2,000 to fulfil the obligation of buying 200 shares at $10.

That also means you don’t want to position size the number of Put options you can sell based on the margin you have to put up.

As mentioned earlier, this is the main reason why many people get into trouble selling Put options.

Be on the safe side and only sell as many Put options as your account size can fulfil on the obligation, if assigned.

But if you don’t plan to get assigned, then you want to ensure a strict cut loss point so that your account don’t get wiped out by an unexpected big move.

3. Avoid Selling Put Options Just For Premium

The third method is to avoid selling Put options just because you can get a lot of premium for it.

There are many traders that simply sell Put options on high volatility stocks.

That’s because when there’s high volatility, the premiums are much juicier.

But the problem with such stocks is that the volatility is high for a reason.

And it’s usually because the market is expecting a big move in either direction.

Which also means there’s a higher chance of the stock going to zero.

While you may get a high premium for selling Put options on such stock, you risk the stock going to zero.

So what type of stocks should you sell Put options on?

4. Only Sell Put Options On Fundamentally Good Stocks

Ultimately, the success of selling Put options is when the underlying stock eventually goes up.

And when you sell Put options on fundamentally good stocks, the probability of the stock going up in the long run is much higher than with stocks that have high volatility but aren’t fundamentally sound.

That’s the reason why I only sell Put options on fundamentally good stocks that I don’t mind owning for the long-term, or broad-based index ETFs (i.e. QQQ, SPY, IWM).

So what is considered a fundamentally good stock?

There are stocks where the company has a history of:

• Increasing revenue.
• Increasing profits.
• Have relatively little debt to their assets.

If you were to take a look at the revenue and net income of Google (Ticker: GOOGL) and Gamestop (Ticker: GME), which do you think is a fundamentally better company?

Clearly it’s GOOGL!

GOOGL has been increasing both its revenue and profits for the past 5 years.

Whereas GME has very unstable revenue, and it hasn’t been profitable for the past 5 years.

However, there are still many people selling Put options on GME.

Why?

That’s because GME gives a juicier premium.

While selling options on GME can be a viable strategy IF you know how to manage your risk well, and you’re good at selecting strike prices that won’t get assigned…

I view it as riskier compared to GOOGL because GME can go bankrupt anytime and the stock can plunge to zero.

Here’s an important thing you need to understand…

If a company is not profitable, then there’s always the risk of it going bankrupt.

But if a company is profitable (and assuming they didn’t cook the books), then it’s impossible for the company to go bankrupt.

And if a company doesn’t go bankrupt, then it’s impossible for the stock to go to zero.

Hence, I prefer to sell Put options on fundamentally good stocks than on stocks that give high premiums.

Conclusion

In conclusion, selling Put options is statistically less riskier than buying 100 shares.

The main reason people get into trouble selling Put options is because they sell more Put options than their account can handle.

And they do not plan for the worst-case scenario and take calculated risk.

But if you plan for the worst-case scenario each time, understand and accept the risk involved, and use the 4 methods I shared with you to make selling Put options safer…

Then you will be able to make selling Put options a viable and lucrative strategy for you.