A tactical approach in the world of options trading, ‘put writing’ offers investors a unique way to navigate the financial markets and holds a blend of creativity, precision, and strategy. It is an all-elusive tool that helps you generate income or purchase stocks at a lower cost.
In this article, we will learn about the fundamentals of put writing in stock market and its strategies, and show you how to make the most of it.
What is put writing?
Put writing is the strategy of selling put options to purchase stocks at a discount or to increase profits. By writing a put, the writer commits to purchasing the underlying stock at the strike price, in the event the contract is exercised. Here, writing refers to initiating a position by selling a put contract. The writer also gets paid a premium or fee for opening a position by selling a put, but until the options contract expires, they are obligated to the put buyer to buy shares at the striking price if the underlying stock drops below that level. However, the writer also owes the put buyer the purchase price of the shares if the underlying stock drops below the striking price, up until the options contract expires.
Put writing for income
Among the many tactics, put writing stands out as a means of generating revenue. Favoured by seasoned traders, it relies on time and accuracy.
Imagine this: as a put writer, you have your eye on a stock that is trading for Rs. 1,000 a share. Selling a put option with a strike price of Rs. 950 allows you to profit from put writing by collecting an upfront premium of Rs. 50 per share. The option expires unexercised and you keep the entire premium as profit if the stock price stays over Rs. 950 until it expires. But if the stock price falls below Rs. 950, requiring the buyer of the option to exercise their right, you will have to acquire the shares at the striking price.
For more insights into trading strategies, explore call and put options and understand market sentiment through put-call ratio.
Writing puts to buy stock
Writing puts offers an opportunity to purchase stocks at lower prices. Investors can generate premiums by selling put options and in doing so they demonstrate their readiness to buy the stock at the strike price. When put options are exercised, effectively, the investor gets the stock at a lower price.
Also Read: What is a BTST trade
Closing a put trade
Closing a put trade is the act of terminating or exiting a put option position. Investors can realise any gains or losses from the trade and be released from any additional obligations associated with the put options by choosing to purchase back the put options they previously sold to close out their position when ending a put trade.
The scenarios listed above entail that the option is exercised or expires worthless. But there's a whole other angle to consider. By purchasing a put, a put writer can close their position at any moment. For instance, the value of a put will increase if a trader sells one and the underlying stock price begins to decline.
The flipside
Put writing is not devoid of dangers even though it might increase revenue or make it easier to purchase stocks at a discount. The put seller might have to purchase the underlying stock at a price greater than market value if the price of the stock declines considerably. In addition, if the stock price rises above the strike price, there's a chance you won't get to enjoy future stock appreciation.
Imagine that you are selling a put option with a Rs. 1,200 strike price, and the stock suddenly drops to Rs. 800. Forced to buy shares for Rs. 1,200 apiece, even though they are now worth Rs. 400 less each, which is somewhat offset by the original premium.
Put writing example
Put writing strategy serves not as a way to make money but as a strategic method for buying stocks at advantageous prices.
Picture this scenario; you have your eye on a stock priced at Rs. 1,800 per share considering it overpriced and ready to be bought at Rs. 1,600. This is where the beauty of put writing shines—you can write a put option with a strike price of Rs. 1,600 indicating your willingness to purchase the stock at that price. If the market doesn't drop to or below Rs. 1,600 before the option expires it remains unused. You keep the premium as your profit.
Conversely, if the stock price dips to Rs. 1,600 or lower the option buyer may decide to exercise it requiring you to buy the stock at the strike price. Despite the risk involved, this strategy presents an opportunity to acquire desired stocks at a reduced cost while also benefiting from the received premium that lowers your overall expenditure. These ventures can be lucrative if approached prudently but necessitate thorough market analysis and a high level of risk tolerance.
Conclusion
Although put writing can be beneficial by facilitating capital increase and share purchase, it is not immune to the risks. It can prove to be a profitable strategy for selling-puts with a rising or stagnating stock since the put premium can be collected. In such a situation where the stock has been dropping, a put seller's risk is still to be considered even though the profit is minimal.
To conclude, investment in equities is not without risks, as large losses might happen if stock prices drop considerably. So an individual interested in the put writing is required to be cautious and do an in-depth study before being recruited.
