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Apparently I really don’t understand options. Why would you sell a put and not buy a put or alternatively sell a call if you think a stock is going to go down?

Apparently I really don’t understand options. Why would you sell a put and not buy a put or alternatively sell a call if you think a stock is going to go down? Or is this saying you believe it’s too high and will remain high likely past the expiration date of the option? Likewise with your second example.

aeternum 4y ago
Selling a put can be thought of as similar to a traditional limit buy order. For example say you think Meta is a buy at $90. But Meta is trading at 109.57, so sell a put with a strike of $90 and collect a premium in return for agreeing to purchase a stock at $90. If the stock hits 90 or below the contract will be executed and you will purchase the shares at $90 (same as you were going to do with a limit order). If it doesn't hit 90, you still pocket the premium. It's like getting paid for having a limit order.
- MikeDelta 4y ago
  Note that this means that, in a more extreme case, if Meta drops to $40, you still have to buy at $90 via the option, realizing a loss of $50 per contract. It's getting paid for taking on risk. A limit order will execute at your level or better, not worse.
pjob 4y ago
The idea is that you have a specific entry price in mind and are waiting until it drops to that point. While you wait, you can collect a premium from selling the option. Let's say that based on your assumptions you think stock X would need to drop to $6 for you to make a good enough risk-adjusted return, but it's currently trading at $7. While you're waiting for the price to drop you could sell a Put (generally a cash-secured put) to collect a premium. If the stock price drops below $6 within the duration of your option, you'll get assigned the stock at the price you wanted ($6), but if it stays above this price the option expires worthless and you keep the premium. There's too much detail to cover in a short comment, but the main risks with a strategy like this is that the price drops well below your strike price and you're forced to buy the stock at higher price than the current market value. For cash-secured puts, you'll also need enough cash in your account to cover the purchase of the stock at your strike price. That said, depending on your mindset and goals, this can be a way to generate income while waiting for the right price. The opposite side of this also applies for exiting positions. You can sell calls on a stock you own (covered calls) to collect a premium while you wait for the price to reach your chosen strike price. The risk being the potential that the price blows past your strike price, your shares get called away, and you don't get to profit from the extra gains above the strike.
clejack 4y ago
You can sell a put at a strike price you believe is reasonable and collect the premium for guaranteed. If the strike is hit, you've bought in at what you believed was a reasonable price at the time of your contract creation. You may technically show a "loss," but you're getting something you wanted at the price you wanted. If you buy a put instead you're effectively saying you strongly believe that the stock will fall to $x, and in this case, the fall to x will generate more money than the cost of the premium. The second scenario is hard to get right because the option already has the statistical behavior of the stock priced into the premium. Your knowledge needs to be better than the collective knowledge of the market to make this viable
- deleted 4y ago
  [deleted]
guga42k 4y ago
What you describe is directional trade (aims to capture up/down moves in underlying). Investment banks usually trade in volatility space, also called delta hedged. Main idea they would sell options (calls or puts) by adding extra premium to the fair price. At the same time they make the whole portfolio delta neutral by buying and selling underlying instruments on daily basis. By having significant portfolio one could expect to leak less on the hedging process and may be use some correlation between underlyings and use index futures instead of individual stocks. The whole business is to capture the premium mentioned above without predicting up or down move.

aeternum 4y ago

Selling a put can be thought of as similar to a traditional limit buy order. For example say you think Meta is a buy at $90. But Meta is trading at 109.57, so sell a put with a strike of $90 and collect a premium in return for agreeing to purchase a stock at $90. If the stock hits 90 or below the contract will be executed and you will purchase the shares at $90 (same as you were going to do with a limit order). If it doesn't hit 90, you still pocket the premium. It's like getting paid for having a limit order.

MikeDelta 4y ago
Note that this means that, in a more extreme case, if Meta drops to $40, you still have to buy at $90 via the option, realizing a loss of $50 per contract. It's getting paid for taking on risk. A limit order will execute at your level or better, not worse.

pjob 4y ago

The idea is that you have a specific entry price in mind and are waiting until it drops to that point. While you wait, you can collect a premium from selling the option. Let's say that based on your assumptions you think stock X would need to drop to $6 for you to make a good enough risk-adjusted return, but it's currently trading at $7. While you're waiting for the price to drop you could sell a Put (generally a cash-secured put) to collect a premium. If the stock price drops below $6 within the duration of your option, you'll get assigned the stock at the price you wanted ($6), but if it stays above this price the option expires worthless and you keep the premium. There's too much detail to cover in a short comment, but the main risks with a strategy like this is that the price drops well below your strike price and you're forced to buy the stock at higher price than the current market value. For cash-secured puts, you'll also need enough cash in your account to cover the purchase of the stock at your strike price. That said, depending on your mindset and goals, this can be a way to generate income while waiting for the right price. The opposite side of this also applies for exiting positions. You can sell calls on a stock you own (covered calls) to collect a premium while you wait for the price to reach your chosen strike price. The risk being the potential that the price blows past your strike price, your shares get called away, and you don't get to profit from the extra gains above the strike.

clejack 4y ago

You can sell a put at a strike price you believe is reasonable and collect the premium for guaranteed. If the strike is hit, you've bought in at what you believed was a reasonable price at the time of your contract creation. You may technically show a "loss," but you're getting something you wanted at the price you wanted. If you buy a put instead you're effectively saying you strongly believe that the stock will fall to $x, and in this case, the fall to x will generate more money than the cost of the premium. The second scenario is hard to get right because the option already has the statistical behavior of the stock priced into the premium. Your knowledge needs to be better than the collective knowledge of the market to make this viable

deleted 4y ago
[deleted]

guga42k 4y ago

What you describe is directional trade (aims to capture up/down moves in underlying). Investment banks usually trade in volatility space, also called delta hedged. Main idea they would sell options (calls or puts) by adding extra premium to the fair price. At the same time they make the whole portfolio delta neutral by buying and selling underlying instruments on daily basis. By having significant portfolio one could expect to leak less on the hedging process and may be use some correlation between underlyings and use index futures instead of individual stocks. The whole business is to capture the premium mentioned above without predicting up or down move.