Managing a Short PUT Position

Learning about managing a short PUT position will be important if you are interested in how to buy stocks at a discount.

Selling PUTs allow you to receive a premium up front while lowering the initial cost basis of purchasing shares should your options be exercised.

Just like anything else though, there is a bit to learn so that you can increase the odds in your favor and come out ahead.

Learning to manage your positions, whether single stock positions or options positions, is part of learning to become a better trader and investor. The people who don't make any attempts to learn ahow to manage their positions are the one's who enter a trade expecting to make a profit and feel they should because they deserve to.

In the previous article I wrote about buying stocks at a discount using PUT options. There are a couple of potential scenarios that may come about after doing so. Here is a list of these scenarios that I'll be writing about below:

  1. If the price of the PUT at options expiration is above the strike price the original PUT's were sold at, allow the PUT's to expire worthless.
  2. If the price of the PUT at options expiration is below our strike price the original PUT's were sold at, allow the PUT's to be exercised.
  3. Buy-to-close the original PUT position and do nothing else.
  4. Roll-down, roll-out or roll-down-and-out the current PUT position.

Let's take a look at an example for each of the choices available when managing a short PUT position using the following common position details:

MSFT last traded at $27.00 a share. We sold 5 of the February 2011 PUT's (5 x 100 shares in each contract= 500 shares if we were to be exercised) at the $26.00 strike price for $0.85, which resulted in our receiving $425.00 into our account. (less commissions but for the basis of this article and for simplicity, we will not include commissions).

  • In the first possible scenario mentioned above (1), when options expiration day comes around in February, 2011 and the price of MSFT is trading at $26.50, we can choose to allow our PUT position to expire worthless, thereby requiring no further action and we enjoy keeping the $425.00 in premium that we originally received when we sold the 5 PUTs.
  • In the second scenario mentioned above (2), when options expiration day comes around and MSFT is trading at $25.50, we can allow our PUTs to be exercised, meaning since the price of MSFT is below our strike price of $26.00, we would become proud new owners of 500 shares of MSFT at $26.00 each since we were obligated to buy shares if prices closed below our strike price.

    Our cost in this scenario would be the $26.00 we paid because of our strike price, less the premium we originally recieved of $0.85, which equals $25.15 per share.

    In this scenario, we managed to purchase our shares of MSFT at a 6.85% discount to where shares were trading at when we originally thought about buying shares when they were $27.00 per share.

  • In the third scenario above (3), an example would be at options expiration day MSFT is trading at $25.85 and we are no longer interested in possibly owning shares of MSFT. Our PUT's would be trading at $0.15 so we could buy our PUTs back (buy-to-close) for $0.15 allowing us to make a profit of $0.70 ($0.85 minus $0.15) (less commissions of course). ($0.70 x 100 shares x 5 PUT's = $350.00 profit)

    If MSFT was trading at $24.15 at expiration, we still owned our short PUT position and we decided we were no longer interested in MSFT, we could buy-to-close our short PUT's for approx. $1.85 and incur a loss. ($1.85 minus $0.85 we received = $1.00 loss x 100 shares x 5 PUTs = $500 loss).

  • Finally, the fourth scenario (4) gives us a few options which allows us to stay in this position as long as we still are interested in potentially owning shares of MSFT.

    Roll-down: Let's say MSFT is trading at $25.75 near options expiration day. We can potentially buy-to-close our short PUT position for less than we originally sold them for, let's say $0.40, which results in our earning $0.45 ($0.85 - $0.40= $0.45 x 100 shares x 5 PUTs = +$225.00) and sell additional PUTs using a lower strike price. This avoids our position being exercised and lowers our potential cost basis even further (if and when we get exercised) because we are now receiving additional premium as income.

    Roll-out: Let's say MSFT is trading at $25.75 on options expiration day. We can buy-to-close our short PUT position for approx. $0.25 which results in our earning $0.60 ($0.85 - $0.25= $0.60 x 100 shares x 5 PUTs = +$300.00) and sell additional PUTs in a further out month. This also avoids our position being exercised and lowers our potential cost basis even further (if and when we get exercised) because we are also now receiving additional premium as income.

    Rolling down-and-out: This would be a combination of above, buying-to-close your short PUT position and selling an additional PUT at a lower strike price (down) at a further month (out).

    You can also roll-out a losing position incurring a short term loss and receive additional premium to counter the loss. An example would be if MSFT is trading at $25.00 on options expiration day and you bought-to-close your short PUT position for $1.00. You would have a loss of $75.00 ($1.00 minus $0.85 x 100 shares x 5 PUTs = $75.00) but you could then sell additional PUTs at a lower strike price in a further out month and receive an additional premium.

If and when you get exercised while managing a short PUT position, there are additional options strategies that can lower your cost even further. Take a look at this 130+ page ebook offered here which goes into deatil about some of these strategies while helping to build a long term income producing portfolio for years to come: Leveraged Investing Guide.




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