Put writing is a widely-used strategy a among options traders. Put writing involves selling a put option, letting the buyer sell a security at a predetermined price during a specified time frame. In return, the seller receives a premium for assuming the obligation of buying the asset if the option is exercised. This strategy is particularly popular for generating additional income and for acquiring stocks at a lower price.
Put writing is becoming more common in India, with traders leveraging it to benefit from market volatility. The NSE has experienced a notable rise in options trading volumes, showcasing the strategy’s growing appeal.
What Does Put Writing Mean?
Put writing refers to the strategy where an option trader sells put options on an underlying asset, such as stocks. By selling puts, the option trader agrees to buy the asset at the strike price if the option is exercised. In return, they receive a premium. Put writing is used by options traders who believe the asset’s price will stay above the strike price, allowing them to keep the premium as profit without having to purchase the asset.
Majority of times, option traders close the written put contracts before expiry to avoid assignment.
How Does Put Writing Work?
Here is a step-by-step guide to help you understand the process of put writing.
- Step 1: Select the asset you wish to write a put option on, such as a stock, index, or other financial instrument. Research its performance history, volatility trends, technical and fundamental parameters, and current market conditions to make an informed decision.
- Step 2: Pick a strike price that matches your market outlook and personal risk tolerance. A lower strike price could bring more buyers but also raise the risk if the price falls below that point.
Traders often look for strong support levels in various assets and choose strike prices near these levels. The assumption is that these support levels are strong enough to prevent the stock’s price from falling below them, thereby making the short put strategy more likely to expire out of the money
- Step 3: Pick the option’s expiration date based on your market expectations. Shorter-term options usually offer higher premiums but come with added risk, while longer-term ones give more time for the market to move in your favour.
- Step 4: Writing a put option allows you to earn a premium as income for agreeing to acquire the security at the strike price if the option is exercised. The strike price, expiration time, and volatility of the underlying asset influence the premium amount.
- Step 5: Monitor the price movements of the underlying asset. You may want to buy back the option to limit your losses if the market shifts against your position.
- Step 6: You keep the premium as profit if the option expires worthless (i.e., the asset’s price remains above the strike price). You will need to purchase the asset at the strike price if you go for an option exercise, which may result in a loss if the price has dropped.
What are the Different Put Writing Strategies?
The most common types of put writing strategies are:
1. Cash-Secured Put
A cash-secured put strategy suggests selling a put option and reserving sufficient cash to buy the underlying stock if an option assignment arises. This approach suits bullish investors aiming to acquire stocks below market value.
Suppose you are willing to buy shares of Reliance Industries, currently trading at ₹1311.6 on 6 December 2024. Using a secured put strategy, you sell a monthly OTM put option with a strike price of ₹1270, expiring in December 2024, to earn a premium of ₹8.1. However, you must set aside ₹1270 multiplied by the number of shares in one lot as a cash reserve to cover the potential purchase.
2. Naked Put Writing
The naked put writing strategy requires you to sell put options without holding a short position in the underlying asset. Also called an uncovered or short put, this risk management strategy involves betting that the underlying security price will either rise or remain stable. If the asset’s price stays over the strike price, the put contract expires worthless, and you keep the premium from the sale.
Suppose you are confident that Reliance’s stock, currently trading at ₹1311 as of 6 December 2024, will not drop below ₹1200 in the next month. You sell a naked put contract with a strike price of ₹1200 and receive ₹2.45 as a premium income. If the stock price stays above ₹1200, the option expires at zero, and you keep the ₹2.45 premium. However, if the stock falls to ₹1100, you incur a loss on your naked put writing strategy.
Naked put writing can be highly risky as the put option’s premium can jump multifold if the price of the stock drops sharply, losses can be significant, thus, it is advised to manage naked put positions meticulously.
3. Rolling a Put
Rolling a put involves closing an existing short put position and simultaneously opening a new one, typically with a longer option expiration (rolling out) or a lower strike price (rolling down).
Suppose you sold a put option on Reliance Industries with a strike price of ₹1200, expiring in December 2024. You received ₹2.5 as a premium. As the expiration date nears, Reliance Industries’ stock price falls to ₹1220, making it likely that the option will be exercised or simply put, the premium price will rise to start incurring losses.
To avoid assignment, you roll the put by buying back the ₹1200 put and selling a new put with a strike price of ₹1185, expiring in January 2025. This move may generate an additional premium, say ₹7 as premium, which offsets a portion of your loss from the original position.
4. Put Spread
Also called bull put spread trading, this strategy requires you to sell one OTM put option and buy one ITM put option simultaneously. You can use this risk-limiting put strategy if you expect a moderate rise or stability in the underlying asset’s price.
Suppose you have a bearish view, and the Reliance is trading at ₹1315 on December 6, 2024. You sell an OTM put option with a strike price of ₹1300 and make a premium collection of ₹13.95. Simultaneously, you buy an ITM put option with a strike price of ₹1330 for a premium of ₹25.4. The net credit you receive is ₹-11.45 (₹13.95 – ₹25.4). Note: The negative net credit is due to the varying call and put premium.
If Reliance remains above ₹1300 and below ₹1315 until expiration, the OTM put option expires at ₹0, and you keep the ₹13.95 premium as profit plus the premium appreciation on the ITM put option. However, if Reliance falls below ₹1300, your maximum loss is limited to ₹13.95 (the difference between the strike prices minus the net credit earned).
5. Delta-Based Strike Selection
For those unaware of Delta in put writing, it is an option Greek that measures how the price of an option reacts to fluctuations in the underlying asset’s price. When writing put options, Delta values vary from -1 to 0, reflecting the probability of the option being in the money at expiration.
These are popularly called delta hedging strategies.
Traders select strike prices depending on these Delta values. A Delta near 0 indicates a low probability of exercise, allowing traders to collect higher premiums with higher risk. A Delta closer to -1 suggests a higher chance of exercise, giving more downside protection but at the expense of lower premiums.
Suppose you are writing a put option on Reliance Industries using this probability-based strategy, currently priced at ₹1,315. You choose a strike price of ₹1,200 with a Delta of -0.4. This suggests a 40% chance the option will be exercised. You retain the premium if Reliance Industries stays above ₹1,200. However, you will be obligated to buy the stock if it falls below ₹1,200, but the premium mitigates the risk.
Why Use Put Writing?
Put writing can be an effective strategy for generating income and managing risk in volatile markets. It allows traders to collect premiums while potentially buying stocks at a lower price. Here are the key benefits of put writing:
Income Generation
Selling a put option means you receive a premium income from the buyer. This provides you with immediate cash. This approach works best when you expect the stock’s price to either stay the same or rise.
For example, if you sell a put option on a stock trading at ₹50 and collect a ₹2 premium, you earn ₹200 (since each contract covers 100 shares). If the stock price remains over the strike price, the option becomes worthless, and you keep the premium as an income from put writing.
Buying Stocks at a Discount
Writing a put option can also serve as a way to acquire stocks at a discount. When you take this position, you agree to acquire the stock at the strike price if the option is exercised. This strategy can be beneficial if you are aiming to acquire the stock for less than its current market value.
For example, by writing a put with a ₹45 strike price for a stock trading at ₹50, you may be required to buy the stock at ₹45 if the price falls to or below this level. After factoring in the premium you received, your net cost because of the discounted stock purchase will be lower.
What Are the Risks of Put Writing?
Put strategy comes with its own set of risks that can lead to significant financial loss. Understanding put writing risks is crucial before deciding to enter into the contract. Here are some pitfalls:
Market Downturn
If the underlying asset’s price drops significantly, you might be forced to purchase the asset at a price higher than its current market value, resulting in substantial losses.
Unlimited Loss Potential
Although writing a put provides upfront premium income, theoretically the stock price could fall to zero but naturally, the potential of losses is substantial.
Assignment Risk
Put writers face assignment risk, where they may be required to buy the underlying asset if the option is exercised. This happens when the asset’s price falls below the strike price, forcing you to take ownership at the agreed price, which could be far above its current market value.
How to Start Writing Puts as a Beginner?
You can consider opting for the following steps to begin, put writing.
Choosing an Underlying Asset
When writing a put contract, choose an asset you are comfortable with. Use technical and fundamental analysis and choose an appropriate script commonly stocks, index, commodity or currency. Not only that, ensure you are familiar with the market conditions affecting the asset. Also, assess its volatility and historical performance to better predict price movements and potential risks.
Setting Up a Brokerage Account
You need a top Demat account that allows options trading to start trading options. Look for a platform that supports selling puts, offers competitive brokerage and has the necessary tools for research and analysis.
Determining Strike Price and Expiration
The strike price is the value at which you may be compelled to acquire the underlying asset. Option traders analyse technical charts of the underlying asset and select strike prices based on subjective technical analysis; for example; a strike price near to the strong support is chosen in case it is speculated that the support price will defend the stock price from falling below it.
Select a strike price that is aligned with your risk tolerance. As a beginner, it’s advisable to select out the money strike prices as they are subject to maximum effect of theta decay. The expiration date points to the time frame in which the option contract will expire. It is crucial to balance between a longer expiration for more premium income and a shorter one to reduce the time decay impact.
Calculating Potential Premium Income
Several factors, including the underlying asset’s strike price, expiration, and volatility, determine the premium you receive for writing the put option. When a security experiences more volatility, you can command a higher premium. However, keep in mind that higher premiums also come with higher risks. It is recommended to use the options pricing model for calculating premium income.
What are the Common Mistakes to Avoid in Put Writing?
To implement successful put writing, say no to the following options trading errors.
- Avoid over-leveraging capital. That means writing more puts than your capital can cover. You may face margin calls if the market moves against you or you cannot purchase the underlying asset.
- Avoid writing puts when implied volatility (IV) is low. IV measures the market’s expectation of future price fluctuations in an asset. It is derived from option prices and indicates possible risk and uncertainty without predicting direction. Low IV reduces the premium earned, and the risk-return ratio becomes less favourable.
- Another common put writing mistake is not planning how to close or adjust the position if the market moves unfavourably. You may hold onto losing positions for too long without a proper exit strategy. Setting stop-loss limits or rolling down to a lower strike price is better to minimise losses.
- Writing puts only for the premiums without evaluating the underlying asset is another beginner’s mistake. Poorly chosen assets can lead to significant losses if assigned.
- Never assume the put contract won’t be exercised if it is out-of-the-money before expiry. Unexpected market events or dividend payouts can lead to early assignment. Stay aware of the factors that can trigger such instances and monitor your positions closely.
- Another common mistake is not incorporating technical analysis or price action to decide which strike prices are safer. Successful traders often find crucial and significant price points on the technical chart of a put option.
What is an Example of Successful Put Writing?
Let’s take a real put writing example of Reliance Industries in the image uploaded below to give you an understanding of successful put trade.
As on 13th December, 2024. An Option trader has used basic technical analysis measures to study and establish a support structure on the chart.
Study the content on the chart to further understand the example in brief.
Let’s take a real put writing example of Reliance Industries to give you an understanding of successful put trade.
- Current share price of Reliance Industries: ₹1272 per share
- Using technical analysis, you objectively decide what is the strong support price of the stock, this helps you to choose a safer strike price.
- Strike Price: Suppose you sell a put option with a strike price of ₹1230 assuming that 1250 will act as a significant support price for buyers to let reliance sustain above 1250 at least by the end of expiry.
- Premium: The premium received for this put option is ₹3.8.
The chart below is the Pay Off chart of the position we created as an example.
Scenarios:
Stock Price Above Strike Price at Expiration:
The put option will expire worthless if Reliance Industries’ stock price remains above ₹1230 at expiration. You keep the ₹3.8 premium as profit.
Stock Price Below Strike Price at Expiration:
You must buy the put option at ₹1230 if the stock price falls below ₹1230. However, your effective purchase price is ₹1226.2 (₹1230 strike price – ₹3.8 premium received).
Simply put, the premium sold at ₹3.8 when price was ₹1272 would rise incurring losses to the trader depending on how fast the price dropped below the strike price as in this case ₹1230. But if the stock price manages to close at or above ₹1230, the premium will decay and the trader will have an opportunity to book profits.
Example Calculation:
- Stock Price at Expiration: ₹1226.2
- Strike Price: ₹1230
- Premium Received: ₹3.8
If the stock price is ₹1226.2 at expiration, you buy the stock at ₹1230 but effectively at ₹1226.2 due to the premium received. If the stock price is above ₹1230, you keep the premium without buying the stock.
This strategy can be profitable if the stock price remains stable or increases, but it carries the risk of buying the stock at the strike price or booking the loss by closing the put written in an expensive premium price if the market moves against you
Is Put Writing Bullish or Bearish?
Yes, put writing is bullish because the writer expects the underlying asset’s price to remain stable or rise, ensuring the put option expires at zero or below the premium collected, allowing them to keep the premium.
What is the maximum profit in Put Writing?
The maximum profit you can make from writing a put option is the premium you receive for selling it. You will realise this profit if the option expires worthless, meaning the asset price stays above the strike price until expiration.
What is the maximum loss in Put Writing?
When writing a put option, the maximum loss is the strike price minus the premium you received, multiplied by the number of contracts. This loss happens if the asset’s price drops to zero.
How to protect against a losing put write?
To protect against a losing put write, you can implement a put spread by buying a put option with a lower strike price. This limits your downside risk while still allowing you to collect a premium. Alternatively, you could roll the put option to a later expiry or lower strike to gain more premium and reduce potential loss.
How often should you roll your puts?
You may consider rolling your puts when the underlying asset moves significantly against your position or if you are approaching the option’s expiration. Typically, rolling is done 1–2 weeks before expiration to extend the trade and capture more premium. However, the frequency depends on market conditions, risk tolerance, and strategy.
Can Beginners Make Money in Put Writing?
Yes, beginners can make money through a put writing, but it requires a solid understanding of options, technical analysis and risk management. Since there is a risk of significant losses if the stock price falls below the strike price, starting with small positions, focusing on Out The Money contracts, liquid stocks, and using protective strategies, such as spreads, to manage potential risks is recommended.
What is the difference between put writing and call writing?
Put writing involves selling a put option, obligating the seller to buy the underlying asset if the price falls below the strike price. On the other hand, call writing involves selling a call option, obligating the seller to sell the asset if its price rises above the strike price.
What is the difference between put writing and put buying?
Put writing involves selling a put option, obligating the seller to buy the underlying asset at the strike price if exercised, earning the premium as profit. In contrast, put buying gives the buyer the right to sell the asset at the strike price, with limited loss to the premium paid.
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