You can’t say that you have unlimited risk in selling puts because the lowest the stock can go is to zero. That is your downside. If the stock is below the strike price, it will get put to you.

You have one other strategy that can be played right up to and through the expiration date. It is called “rolling out.” Here’s the way it works. Let’s say the stock is at $46. Last month you sold the $50 put for $2.25 when the stock was at $48.50. You had hopes it would go up. It hasn’t. If you have to buy the stock, your basis will be $47.75, as you have received $2.25. One problem is the heavy duty amount of cash you’ll need to purchase the stock—even $25,000 on margin.

You think you could find a better use for the money. The put is currently $4.25—buy it back. Actually, you’re just purchasing the same put (strike price, month) as you sold. This will close the position—it’s a wash on your broker’s computer. If you had ten contracts, you would have lost a little over $2,000 after you add up the commissions. You could just end it here, but don’t. There’s another play.

Remember, you liked this company’s stock at this price. Check it out. Is the story line still in place? Yes, it didn’t go above the $50 like you planned—at least, not yet. If you still think it will do so, roll on out to the next month.

Let’s continue. Try to catch the stock on a dip—even if in a roll or slam in trading. Say it’s going between $46⁵/8 and $46^3/4. It occasionally drops to$46²/8. At that point sell the November $50 put. It’s going for $4.50. That’s $4,500. You’re back in the money again, and you’ve made a profit.

If you don’t think it will go above $4.50, look at the $45 put. It’s going for $2′/8, or $2,125. If you sold this you’d about break even on the original loss. Yes, you have an open position to buy the stock at $45, but your homework says it will go up.

Another method would be to split the contracts. Say, sell five of the $50 puts and five of the $45 puts. You should and could consider purchasing $45 or $50 calls. Maybe the $45s for November, and the $50s for February.

It keeps going down. Believe me, there will be an end to this—you will eventually make money. The next month the stock is at $44. Let’s stick with the $50 puts as that will be most drastic. You sold the November 50 puts for $4.25. It will cost $6.50 to buy them back. This purchase will throw you back in the loss column. Not by much, though.

You’re sure, this time, that the stock will turn around. It just has to (or so you hope). So spend the money—$6,500. Now the December $50 puts are going for $8 and the $45s are going for $2. Sell the $45 puts. You’re profitable again. Also, look at the $40s—there might be some premiums there.

Now the stock moves back up to $47. Your December $45 put expires worthless, and you’ve made over $2,000 for all this trouble.

This could go on several months—but sometime (hopefully) the stock will turn around. When it does, you end it and keep the best batch of each. When you buy back this month’s put, you can always sell the next month out for more money.

And Finally

There are two more considerations.

1.    You may want to consider only selling, or at least primarily selling out of the money puts, i.e. you sell the $50 put when the stock is at $52. This gives you a cushion. The problem is that the premiums are smaller and you have to weigh out the amount of margin tied up for the smaller option premium.

2.    Stick with stocks in the $5 to $25 range. Selling puts and writing calls have a lot of the same risk/reward features—only in reverse. If you want nice premi­ums on stocks which won’t kill you to buy, the lower priced stocks may work better.

Remember, when you sell you have many ways of making money (see “Tandem Plays”). When you buy call options or put options you only have one. This rolling out strategy lets you stay in the game until you make money.

It’s simple: you generate cash whether you have to perform or not. If you do have to buy the stock, you purchased it at a less expensive price than otherwise. I love selling puts because you get the best of both worlds—cash now and wholesale prices.

1.    The stock is rolling between $13 and $20, and has done so frequently. You know this from looking at its chart.

2.    You have heard good news from the company— i.e., new products, expansion, great earnings, et cetera.

You could buy the stock or buy the $12.50, $15 or even $17.50 call options. If the stock rises as expected, the value of your investments increases. Both of these choices require an expenditure of money. If you buy the stock on margin, you only have to put up a percentage of the money (in most cases 50%). I bring this up here because margin requirements will be necessary when selling puts—see the section on “cash requirements.”

Let’s not buy the stock or call options. Let’s sell a $15 put, or even the $12.50 put, if you think the stock may go down further. What does this mean? Let’s use the $15 put example first. If you sell a $15 put, you are literally committing yourself to buy the stock at $15. You no longer have just the right (as in buying an option), you now have the obligation to perform, if the stock gets “put to you.”

You see, by writing a put (selling), you have given someone the right to sell you the stock at $15. They don’t know who you are—all they have done is purchase a put option—giving them the right, not the obligation, to sell the stock to someone at $15. When would they do this? When the stock is below $15. Now, if the stock is at $14.75 or $14,875 on the expiration date, it’s iffy whether or not it will get put to you. (See “Selling Calls” in the Wall Street Money Machine for more information on the execu­tion of these close orders.) However, if the stock is at $14 or $13 it will get put to you at $15.

What did you get for selling the put? And when will you get the cash? The premium you receive is determined by how far the strike price is in the money or out of the money, and how long until it expires.

Selling (naked) puts is a very unique and seldom-used strategy with a host of benefits. We will put some flesh on this skeleton, and some muscle, give it a brain and put it to work for you.

Definitions are in order. Stock option investing gives an investor the right, but not the obligation to buy or sell a particular stock at a set price (strike price) on or before a certain date. Call options give the investor the right to buy a stock. These options can be bought or sold. Put options give the investor the right to sell a stock. They, too, can be bought or sold.

Strike prices for all options are the same. They start at $5, and go up by $2.50 increments to $25, in $5 increments to $200 and in $10 increments thereafter. Options are written in 100 share contracts. Hence, a 75cent option will cost $75 for one contract. Options are derivatives. A derivative is a proxy investment based on an underlying security. Stock options are different than most derivatives in that the investor actually has the right to take control of (own by purchasing or selling) the underlying stock.

Options end—they expire. Because they are a fixed-time investment, investors should not only be wary and very cautious, but should invest in options by keeping an eye on the time clock. You may have the best horse on the track but if it falls behind or gets a bad start, the race may be over before it begins. The price of the option is broken into two parts. Part of the premium is actually purchasing the time until the option expires. This is called time value. If the stock price is above the strike price (call options) or below the strike price (put options), the option is said to be “in the money.” That portion of the option which is in the money is called intrinsic value. I will use several examples and this definition will come to life. Understanding time value (extrinsic) and intrin­sic value is not only important, but sine qua non to effectively making decisions on which option to purchase on a particu­lar stock.

Put options, and a particular angle to using them, is the topic here. Let’s keep exploring them. If you purchase a put option, you are thinking (hoping) that the stock will go down. What if, however, you don’t think the stock is going down? In fact, you think the stock is a winner. Is buying the stock or buying a call option on the stock the only way to take advantage of an increasing stock value?

No, selling puts is another strategy which accomplishes two major objectives:

1.    It generates new income.

2.    If you have to buy the stock, it lets you buy wholesale.

There are other minor strategies which allow for even greater returns.

WANGO means Watch And Get Out. Let’s say a stock is having a nice run up. You are quite profitable on your option but want to get out at maximum profit. Ask your stockbroker to keep an eye on it. If it peaks and you can catch it at or near the peak, then you can get out with an even greater return.

An example: the stock was at $80 after a slam, or other bad news, or even after good news. It goes to $81. You call your stockbroker and buy the $80 calls for $3 and the $85 calls for $1.25. The stock goes to $83, then $84, and one hour before the market closes it’s at $85—almost $86. The stock hangs around $86, seems to have stalled, backs off to $85.50 with 10 minutes before the close—this is it—(yes, there is tomorrow but this is today). Carpe diem. Seize the moment. Sell and take your profits. The $80 call is $6.25 and the $85 call is $3.75. That’s a $3.25 profit on the $80’s and a $2.50 profit on the $85’s. It’s been a nice day.

Yes, it may still go up tomorrow, but many times they fall back. This stock had a 3%, then 4%, then 5% run up in one day. Surely I can’t tell you what to do, but I usually take my profits and wait for another dip.

Two more points:

A. The options market closes ten to fifteen minutes after the stock market. If you are willing to buy at the ask and sell at the bid (buy or sell at the market), you can still trade options at 4:05 pm, 4:10 pm, sometimes even 4:15 pm (Eastern time). Why do I bring this point up here? Many times, stocks go up or down a few dollars right at the close. If the options have a corresponding move, you could get out at a higher price or get in at a lower price.

However, unless there is really spectacular news (good or bad) which comes out over night, the options are usually pretty much the same the next morning. Just once in a while, I do option trades after the stock market closes.

B. If you have a good profit you could sell part of your position and keep part active. You don’t have to sell all four contracts you’ve purchased. Sell part to capture some profits now and keep some to cap­ture larger profits later.

You might even be profitable enough on the ones you’ve sold to regain all the money spent on all four contracts—you now own the two contracts you’ve kept, for free.

Of course you shouldn’t get out if there’s more potential, but if this was initiated as a quick play, then take your profits and look for another deal—dips, new stock splits, et cetera. So what if it goes to $4. The next day it could be at 50tf.

Stocks and options are like ocean waves. They ebb in, they flow out. Nothing stays the same.