Why Sell Put Option Contracts?

Selling put options is the best way to earn income if you want to enter a stock position. 

Example without any technical jargon:

I want to buy Microsoft at $100 a share. I believe it is undervalued at $100 a share. I would love to own Microsoft at $100 a share! Here is how a put contract sale will work.

You make an agreement with someone where you promise to buy Microsoft stock from them at $100 per share in the future if they want to sell it to you. In exchange for this promise, they give you some money upfront, let's say $5.

So, in this agreement, if the person decides they want to sell Microsoft stock to you in the future at $100 per share, they can. But if they don't want to sell it or the stock price goes up, they don't have to, and you get to keep the $5 they gave you.

So, you're essentially selling them the option to make you buy Microsoft stock from them at a certain price in the future, and you're getting paid upfront for it. If things go according to plan and the stock price stays the same or goes up, you keep their money. If not, you may end up buying the stock from them at the agreed-upon price.

What's the typical length of these contracts?

They can be long or short but a sweet spot seems to be around one month. So you sell the contract for $5 and wait for one month. If in one month the stock price doesn't change or goes up, you get to keep the $5.

What's the typical return I can expect?

What is great about put option sales that it is all just math and returns are easy to calculate. Typical return without taking on too much risk is 1.5% - 2% a month on the money you put up. Probability of 1.5%-2% return is around 84%-90%. That is 18%-24% a year return without compounding.

Any Downsides?

• You can't make more than the set 1.5-2% a month, even if the stock skyrockets 100%+ in a month.

• You need to put up a lot of cash upfront and can't access it in case the stock drops in price and you need to buy the stock at the determined price at the end of the month. That is why it is crucial to actually want to own the stock anyways. 

Worst case scenario example:

Going back to the Microsoft Example. After one month the stock drops to $90. We sold the contract at $100 price so we have to buy the stock at $100. In theory there is 10% loss on a stock but that is only true if we panic and sell at $90 to solidify the loss. Remember, I mentioned that we loved Microsoft at $100 and thought it was undervalued. So you should be happy to hold the stock at a lower price unless of course the business changed and you no longer believe that the stock is worth more than $100. That is why research is crucial.

Also we get to keep the $5 we got upfront so the loss is actually 5% if you do decide to sell.