While Options can be a very powerful tool to help you increase your profits and wealth…
It can also be very dangerous when used wrongly.
You may have heard of many people making lots of money trading Options.
But there are many more people that have lost all their money, and some even have their lives ruined because of Options.
So how do you avoid this disaster and ensure that you’re profitable in the long run trading Options?
The answer is to only trade safe Option Strategies.
So in this post, I’m going to share with you the Top 3 Safest Option Strategies that you can use, even if you’re a beginner.
Let’s get started!
Safe Option Strategies #1: Cash Secured Put
The very first safe Option Strategy to use if you’re a beginner in Options trading is none other than the Cash Secured Put.
So what is a Cash Secured Put?
First of all, let’s define what a Put Option is.
If you’re the buyer of a Put Option, it means you have the right to sell the underlying stock price at the strike price.
For example, if you have 100 shares of stock at $200 and you bought a Put Option with a strike price of $190…
It means that if the stock drops below $190, you have the right to sell 100 shares of the stock at $190.
So if the stock crashed to $50, you’d still be able to sell 100 shares of your stock at $190.
That means the loss per share is only:
$200 – $190 = $10
If you didn’t have the Put Option and the stock dropped to $50, your loss per share would be:
$200 – $50 = $50
So buying a Put Option serves as a protection in case the stock drops.
On the other hand, the Cash Secured Put is the seller of a Put Option.
That means you are the counterparty to the person who bought the Put Option.
So if that person decides to exercise his Put Option to sell 100 shares of his stock at $190, it means you have the obligation to buy those 100 shares at $190.
Therefore, the Cash Secured Put is simply a Short Put, where you have the funds to fulfill the obligation to buy the 100 shares at the strike price if the Short Put is exercised.
So why is this Option Strategy considered good?
That’s because you get “paid” while waiting to buy your favorite stock at your desired price!
And the reason you get paid is that this is a premium-selling Option Strategy.
That means you sell a Put Option and receive a premium for doing so.
And because of this premium, you are essentially buying the stock at a discount!
It’s a fantastic way to get Long stock, and is much better than the traditional way of placing a Buy Limit Order.
Let me explain this in detail so you will understand why.
Buy Limit Order Versus Cash Secured Put
So imagine there’s a stock that is currently trading at $108.95.
You like this stock and you want to buy 100 shares of stock.
However, you feel that $108.95 is still a little too expensive.
You would like for it to drop to $100 before buying the stock.
So you place a Buy Limit Order at $100 to buy 100 shares of the stock.
Now, at this point, there are two scenarios that can happen.
Scenario 1: The price goes up
If the price goes up, you won’t get filled and you won’t own the stock.
Instead, you will just see the stock go up without you.
Very sad, I know.
Scenario 2: The price goes below $100
Congratulations, you got filled 100 shares at your desired price!
The total cost of the 100 shares would be $100 multiplied by 100 shares which equates to $10,000.
So placing a Buy Limit Order is the most traditional way that many people use to buy stocks.
Now, let’s take a look at what happens when you sell a Cash Secured Put instead.
This time, instead of placing a Buy Limit Order for 100 shares at $100, you sell a Cash Secured Put at the strike price of 100.
To know how much premium you can get by selling the 100 strike price Put Option, you take a look at the Option Chain on your brokerage platform.
Take a look at the 100 strike price Put Option with 30 days-to-expiration (DTE).
It shows that the Bid is $2.45 and the Ask is $2.53.
The Bid is simply the highest price that someone is willing to pay for that Option (Note: that “someone” is usually the market maker).
The Ask is the lowest price that someone is willing to sell that Option at (Note: that “someone” again is usually the market maker).
When selling Options, we never want to just sell at the Bid.
That is the worst price that you can possibly get.
Instead, we always want to sell at the Mark, or higher.
The Mark is basically the mid-price between the Bid and the Ask.
And many times, you can get filled at the mid-price.
If you sell at the Bid, you would only receive $2.45.
That is $245 per Put Option sold (each Option contract controls 100 shares).
But if sell around the Mark, you would probably receive $2.50 or higher.
That’s a difference of at least $5.
It may not seem that big, but if you had the available funds and sold 10 Put Option contracts…
That would be a difference of at least $50.
So by selling the Cash Secured Put, you received a premium of $250.
Let’s see what happens in two different scenarios.
Scenario 1: The stock is above $100 at the expiration date
If the stock is above $100 at the Put Option’s expiration date, then the Put Option expires worthless and you get to keep the $250 in premium received.
Whereas if you had placed just a Buy Limit Order, you wouldn’t have gotten this $250.
And now that the Put Option has expired, you can sell another Cash Secured Put and collect a premium again.
That’s how you get an “income” selling Cash Secured Puts!
And that’s what many people do.
Each time they sell a Cash Secured Put and it expires worthless, they sell another one again.
And you can keep doing this until your Put Option gets exercised.
This leads us to the next scenario.
Scenario 2: The stock is below $100 at the expiration date
So what happens if the stock is below your strike price of 100 at expiration?
If the stock is below $100 at the expiration date, then your Put Option will get exercised.
You will then be assigned 100 shares at $100.
But you will still get to keep the $250 you received for selling the Put Option.
And because you received the $250, your effective cost price for buying the 100 shares is:
($100 x 100 shares) – $250 = $9,750
That means your average price of getting the 100 shares is $97.50!
If you compare that to the Buy Limit Order, that is a 2.5 percent discount!
That is why the Cash Secured Put is a superior method of buying stocks compared to the traditional way of placing a Buy Limit Order.
When To Sell Cash Secured Puts?
If you want to sell Cash Secured Puts, then you want to sell them only during the right time.
That’s because if you sell it at the wrong time, you could be missing out on bigger profits.
So here are a few tips to help you sell Cash Secured Puts at the right time.
Tip #1: Sell Cash Secured Puts when the market is dropping.
The reason you want to sell a Cash Secured Put when the stock is dropping is that you will get a higher premium.
You see, one of the factors that determine whether the Put Option’s premium is juicy or not comes down to its implied volatility.
If the implied volatility is low, then the premium you receive is low.
And if the implied volatility is high, then the premium you receive is high.
And the time when the implied volatility is high, is when the stock is dropping.
That is why you ideally want to sell Cash Secured Puts when the stock is dropping.
Tip #2: Sell Cash Secured Puts only on fundamentally good stocks (or broad-based index ETFs) that you want to own for the long-term.
The main objective behind the Cash Secured Put is to ultimately be Long stock.
That is why you only want to sell Cash Secured Puts on stocks that are fundamentally good.
That’s because fundamentally good stocks have a higher probability of going up in value in the long term compared to stocks that aren’t fundamentally good.
If you sold a Cash Secured Put on a stock that gave a very high premium but is not a fundamentally good stock…
Then, in the long run, the stock may not even go up at all and you will lose money on that stock!
So how do you define what is a fundamentally good stock?
While there are many factors that define what a good stock is, in general, the characteristics of a fundamentally good stock is a company that has:
- Increasing revenue over the past 5 – 10 years
- Increasing profits over the past 5 – 10 years
- Relatively very little debt compared to their cash on hand.
By selecting a good stock, there’s a higher probability that the stock will go up in the long run.
Tip #3: Only sell Cash Secured Puts when you have sufficient funds to buy 100 shares of the underlying stock.
This is where many beginners tend to get into trouble when selling Put Options.
Many times, they sell a Put Option with no intention of buying the underlying stock.
And because of that, they put up just the margin needed to sell the Put Option and hope it expires worthless.
The problem arises when the stock starts to tank and they have no plan to exit their trade.
So they become a “deer in the headlights” and just watch the stock crash and end up getting a margin call on their account.
To avoid this situation, always ensure that you have enough cash in your trading account to buy 100 shares of the underlying stock at the Put Option’s strike price.
This way, if the Put Option gets exercised, you have nothing to worry about because you have the cash to fulfill the purchase.
And you give yourself a chance to profit on the shares when the stock eventually goes back up.
Tip #4: Sell Cash Secured Puts only when you can collect enough premium.
To get the best “bang for your buck”, you only want to sell Cash Secured Puts when you are able to get at least 20 percent Annualized Return on Investment (ROI).
The formula to calculate the Annualized ROI is this:
Premium Collected / Strike Price /Option DTE x 365 days
So for example, if you sold the Put Option with a 100 strike price for $2.50 with DTE 30, then the Annualized ROI would be:
$2.50 / $100 / 30 x 365 = 30.41 percent
So this meets our criteria of at least 20 percent Annualized ROI.
Now, you might be wondering:
What if the strike price that I want to sell gives less than 20 percent Annualized ROI?
In this case, you have 3 choices.
Choice #1: You could just sell it anyway.
If you don’t mind collecting a lesser premium, then you can definitely still go ahead to sell that Cash Secured Put.
But if you don’t think the premium is worth it, then you can go with the next choice…
Choice #2: Wait for the stock to drop a little bit more before selling the Cash Secured Put.
If you’re willing to wait for the price to drop, and you don’t mind that there’s a possibility that the stock could just go up from this point and never return back…
Then you can simply just wait till the stock drops a little further down before selling the Cash Secured Put.
This is my preferred approach.
But what if you want to sell a Cash Secured Put right now to collect premium, but also want at least 20 percent Annualized Premium?
Then you would go with the next choice…
Choice #3: Sell a higher strike price.
If you truly can’t wait and don’t mind getting assigned the stock at a higher price than you had originally intended…
Then, by all means, you can sell a Put Option at a higher strike price.
This way you would be able to get a decent premium.
And also have a chance to get assigned on the stock, if the stock price is below your strike price at expiration.
And if the stock is a fundamentally good stock, then you don’t have to worry because it will very likely eventually go up in the long run.
Alright, now that you know how to sell a Cash Secured Put, it’s time to put what you’ve learned into practice!
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