With Put Options, Portfolio Strategy is of Premium ImportanceAdvice to the Advisor
While put option buyers are interested in insuring their risk, put option sellers (also called put writers) are willing to take on that risk in exchange for additional portfolio income, explains Dave Gilreath, Sheaff Brock Managing Director. That income takes the form of premiums paid by the put buyer to the put seller.
Put writing is a strategy whereby an investor writes a contract, selling that contract to a buyer. The contract obligates the put seller to buy shares at a specific price (the “strike” price) at a specific point in the future.
“If timed correctly, a put writing strategy can generate profits for the seller as long as he or she is not forced to buy shares of the underlying stock,” Investopedia.com observes. “One of the major risks the put seller faces is the possibility of the stock price falling below the strike price, forcing the put seller to buy shares at the strike price.” But, if the stock price remains constant or rises, the put seller is able to collect premiums without incurring losses.
Option traders use the key term “moneyness” to describe the strike price’s position relative to the market price of the underlying stock or index. When the underlying asset reaches the option contract’s strike price, the option is “at the money.” If a stock or index is currently valued at $72, for example,
- An “at the money” put option would have a strike price of $72.
- An “in the money” put option might have a strike price of $75.
- An “out of the money” put option might have a strike price of $70.
The Sheaff Brock Index Income Overlay strategy portfolio, as Managing Director Dave Gilreath explains, is focused on exchange-traded put index options, whereby, in each trading decision, the portfolio is exposed to an entire market segment (using an ETF that tracks the S&P 500 Index), thus achieving diversification and mitigating risk.
With put options, portfolio strategy is of premium importance!