If you want a simple Option trading strategy that has a high probability of success, then there’s no strategy simpler than the Short Put strategy.
But don’t be fooled by it just because it’s “simple”.
That’s because not only is it highly profitable when traded properly, but it’s also the quickest way to profit when you get the direction right.
Many new traders often avoid trading the Short Put because they see it as a “risky” strategy.
However, that cannot be further from the truth.
If you apply the right risk management and have a proper capital allocation, it is often much more profitable than trading the Short Put Spread (aka Bull Put Spread).
So how exactly should you trade the Short Put to increase the profitability and win rate?
Here are 3 entry tactics to help you do so.
Short Put Entry Tactic #1: Use Support Levels
Support levels are areas where the price has shown to have strong buying pressure.
Support Levels In An Uptrend
The chart above shows a stock that is in an uptrend.
In an uptrend, the stock will form higher highs and lower highs.
These lower highs are placed where the market temporarily went down first before coming back up.
So all these lower highs are areas that can serve as potential support levels.
And because the Short Put is a neutral-to-bullish strategy, to increase our chances of success, we want to place our Short Put strike below these areas.
This way, when the stock comes down to near these levels, they have a higher chance of it going back up than it going down.
Support Levels In A Downtrend
In a downtrend, the stock will form lower highs and lower lows.
It’s these lower lows that can potentially be support levels for the stock.
So while the market may have the tendency to break these lower lows, there still are opportunities to enter into a Short Put trade when the market is in a downtrend.
And again, ideally, we want to place our Short Put strike below these lower lows when the market has shown some exhaustion in its price action.
This is usually when a reversal can happen.
And when you trade the Short Put in such situations, the profit can come very quickly.
Support Levels In A Sideways Market
In a sideways market, the market will form irregular non-uniform highs and lows.
As you can see in the chart above, the market will be forming lower lows and lower highs, followed by higher lows and higher highs.
And then it goes back to lower lows and even higher highs.
So when a market is going sideways, this can also be a good opportunity to trade the Short Put because it doesn’t much as much compared to when the market is in an uptrend or downtrend.
The key is to identify the support areas on the chart.
And these are formed by all the previous lows.
In the chart above, the area in blue denotes the price area where there’s likely to be buying pressure the next time the market trades down there again.
So what we want to do as smart Option traders, is to place our Short Put strike below this blue support area.
This will give us a higher probability of the trade working out.
Short Put Entry Tactic #2: Sell Put Options Only In Oversold Conditions
If we were to categorize the market into different market conditions that exist at any one time, it can be categorized in just three ways:
- An overbought market condition.
- And oversold market condition.
- A neutral market condition.
An overbought condition is when the market has already gone up for some time and the momentum seems to be weakening.
That is to say, the market is likely to reverse back down when it is in an overbought condition.
An oversold condition is when the market has already sold off quite a bit and the selling pressure seems to have eased off a little.
That is to say, the market is likely to go back up (even if it’s just for a short while) when it is in an oversold condition.
A neutral market condition is when the market is neither overbought nor oversold.
It could signal that the market is going sideways, or that the market is simply in a retracement before continuing its uptrend or downtrend.
So if you are trading the Short Put, where it makes its quickest profit when the market goes up, in which market condition should you enter a trade?
Clearly, it would be when the market is oversold.
That’s because that’s the time we’d have the highest chance of the market going back up.
Now, of course, an oversold market condition can become even more oversold.
That means the market can still go down further even when the market is in an oversold condition.
But it’s better than entering when the market is in a neutral or overbought condition.
Ultimately, trading Options is a probability game.
You will have winners and losers.
Loser can’t be avoided.
However, by entering the Short Put trade when the market is oversold, you put the odds in your favor to become profitable in the long term.
So how do you identify whether the market is overbought, oversold, or in a neutral condition?
By using an indicator called the Stochastic Oscillator.
When the market is overbought, the squiggly blue line will be above the top purple line.
When the market is oversold, the squiggly blue line will be below the bottom purple line.
And when the market is neutral, the squiggly blue line will be in-between both purple lines.
With the Short Put strategy, we enter into a trade when the blue line is below the bottom purple line.
The chart above shows the market is in an uptrend.
Each time the Stochastic Oscillator shows an oversold reading, the market ends its retracement and continues in its uptrend.
The chart above shows the market is in a downtrend.
And each time the Stochastic Oscillator signals an oversold reading, the market goes up.
Even if it’s just a retracement, it’s still more than enough to take some profit on our Short Put trade.
And in a sideways market, there are lots of opportunities to enter into a Short Put trade when the Stochastic Oscillator is showing an oversold reading.
Many times, the oversold signal coincides with the bottom of the price range.
So by using the Stochastic Oscillator to identify when the market is oversold, you increase the odds of your Short Put trade becoming profitable.
Short Put Trade Tactic #3: One Standard Deviation
The image above shows the risk profile of the Short Put.
If you noticed, there is a gray-shaded area on the risk profile.
This gray-shaded area is the one standard deviation move of the underlying stock.
A one standard deviation move is basically where the market expects the underlying stock to trade most of the time.
And if you see the line at the left-hand side of the gray-shaded area, it’s at the price of $374.40.
That means to say, the probability of the underlying stock being below $374.40 at expiration is very low.
To be exact, there’s only a 15.81% chance that the underlying stock will be below $374.40 at expiration.
And for our Short Put to be profitable at expiration, the underlying stock has to be above our strike price.
So if you place the Short Put strike below $374.40, you will have at least an 84.19% chance of being profitable.
That’s how you increase the odds in your favor just by being strategic in your strike price selection!
Now that you know the three entry tactics, you can combine all of them to have a winning Short Put strategy.
So when you put it all together, what you’re looking for is the following:
Step 1: Identify the support levels on the chart.
Step 2: Look at the Stochastic Oscillator to see which support level coincides with an oversold reading.
Step 3: Once both the conditions in steps 1 & 2 are met, choose the strike price that is about one standard deviation away (approximately 16 – 20 deltas).
Step 4: If the strike price is below the support level, enter into the trade.
With these four steps, you will greatly increase the odds in your favor when trading the Short Put strategy.
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