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why not sell put options to add to a position?


claphands22
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Guest Bronco

This can be used effectively in my opinion but you really need to watch your leverage and make sure you have plenty of capital.

 

I use sometimes and make sure I have cash available if the stock gets "put". 

 

Buffett did this with Index funds - will make a fortune.  But just be careful and don't overleverage.

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Buffett did this with Index funds - will make a fortune.  But just be careful and don't overleverage.

 

count the dollar value of your contracts if put to you so you know your max potential liablity. delta & the rest of the greeks are meaningless if your hope & intention is to buy at the strike. except the implied volatility...the higher that # the juicier your premium & the lower your cost

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Buffett also used short puts to acquire a bunch of the original BNI.

 

Assuming they are cash covered, you are risking your great purchase idea going up while you make a couple of bucks and watch from the sidelines.  Writing puts on companies you want to own at the strike price is a fine way to generate income, but can obviously leave you with a bunch of stock and no cash in a downturn.

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Or it can leave you with a margin call in a downturn and force you to unload your position at a loss!

 

When you buy a long stock your margin ranges from 30% cash/70% leverage to 50/50 or something less.  Selling puts is essentially the inverse of this.

 

Sell GE puts at $18 for $1.00.  GE at 20.  At the time of sale you need to have margin coverage of 20% the underlying stock price plus the price of the option:  This adds up to $5.00 in margin. 

 

Using margin is not an issue if you write a small number of puts.  It becomes an issue if you overdo it in the put writing department which is easy to do.  I dont find it an easy way to make significant returns unless you spot an unusual situation. 

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Guest Bronco

Anyone care to quantify this? 

 

I would suggest that your exposure (total dollar amounts that would be put to you - i.e. strike x 100 x # of options) would be no more than 20% of your entire portfolio but to be safe I would recommend 10%.

 

And write puts on stuff that is less likely to impload. 

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Another thing to consider is if a position goes in your favour before expiry.  You sell puts at $2.00/share - the price of the stock goes up - your puts are quoted at 0.30 and there is still two months to expiry - get out with your gains.  The goal here is too make money not end up with the stock. 

 

I know whereof I speak on this topic.  Prior to and into the financial crisis I thought I might make a little extra money selling puts.  Without exception I was forced out of my positions at a loss.  Due to the confluence of events I got hit with margin calls and had to buy my way out of bad positions. 

 

An early chapter in the Buffett's Next Door features a fellow who has successfully employed put selling and covered call selling strategies.  It seemed that he does well at it.  Worth a read. 

 

Another issue with put writing is obviously taxation. 

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