Monday, March 16, 2009

Writing Puts

Writing puts is probably the strangest of the four single options positions. First, it's hard enough for most people to understand what a "put" is and why someone would want to buy a put, which is the "right to sell stock at a set price." But, if you feel that Starbucks is about to drop, you can buy a put to see if you're correct. If so, the put becomes more valuable. Or, if you already own Starbucks common stock and are afraid it could drop, you could buy a put to protect yourself. If you have the "right to sell SBUX @20," it doesn't matter if SBUX drops to 5, or even 0--somebody has to let you sell the stock to him for $20. Who is that somebody?
Somebody who wrote the SBUX 20 put. He sold you the put a while back because he was convinced the stock would stay at $20 or higher (bullish/neutral). Turns out, he was wrong, and now he has to let you sell him the stock @20. He has the "obligation to buy the stock at 20," in other words. Notice how I try to focus on the buyer's perspective--he has the right to sell the stock for $20, so the seller of the put has to honor that contract. Or, we could say that the put writer is "obligated to buy the stock at the strike price."
Okay, so if I am "bullish" on Starbucks (SBUX), I can buy calls on SBUX. If the stock drops, I could lose the entire premium paid for the call options. Or, I could sell/write puts on SBUX, thinking the stock will either rise or stay where it is. Some people prefer to take money in from an option by selling, but if the stock drops, the put writer can get bruised pretty bad. If you sell a SBUX Sep 20 put @2, the stock could drop to 0. And then you'd have to pay $20 to somebody for a worthless stock, with only a $2 premium to show for it. And, the higher the strike price, the bigger the risk to a put writer. I don't want to be "obligated to buy" a worthless stock for $80, $90, $100. Of course, I don't write options, or buy them. We have plenty of riverboat gambling in the greater Chicago area if I feel a need to throw my money away.

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