Selling Put Options on Tech Stocks for Income

Selling puts is an options trading strategy that can be used to generate short-term income. It's a more intermediate trading method; options beginners should probably master the long call and long put first. Over the last couple of years, the short put strategy has produced a most successful run by just trading a select few technology stocks like Apple Computer.

While this article isn't intended to explain all the ins and outs of trading put options (that would take an encyclopedia!), a summary of the short put, or selling puts, follows.

Other hub writers like Kidgas and Chuck have published detailed articles about the short put. There are volumes of information available, much of it free, for those wanting to learn more about options trading. Books, online sites, and television (like on CNBC) offer options education. Take advantage of it if you are interested in learning more about options. Learning more about finance is one of the best ways to take personal responsibility and control of your own financial well-being.

Selling an option:

• is a bullish strategy. It's used when you expect the price of the stock to go up, or at least not go down that much. In that way it is like buying an actual stock, because when you buy a stock, you want or expect the price to go up, right?
• is a credit strategy. Money will go into your account when you initiate the trade. This is unlike buying the stock itself, where money leaves your account for the purchase.

The Short Put is an option contract where you sell the right to sell a stock at a specified price (the strike price) on or before a specific date (the expiration date).

With a short put, you want the options to be high priced when you sell them, then you want them to decline in price as time goes on. If the stock price goes up, the put option price goes down. If all goes well the option value will go down to zero on expiration day and you will get to keep all the premium received in your account from selling the option. This is buy low, sell high in reverse. Sell high first, then buy low or let it expire at zero later.

I don't have the guts for margin trading or naked shorts so I only use cash covered puts, which means I reserve a large amount of cash in the account to cover buying the stock if it drops down to my strike price at expiration. Having to purchase the stock is not a bad thing because I am getting it for a lower price than it was previously. It's like buying something "on sale" and getting paid to wait for the price to drop.

To sell a put, I choose only quality stocks, quality companies. Or I use ETF's like QQQQ which let me participate in a total diversified market movement. I look for an overall bullish trend.  I pinpoint a reasonable strike price where there is a decent premium. I time the trade for the front month - options should be expiring in 30 days or less. I sell one or more contracts to initiate the trade, then watch the price action and wait for time decay to start kicking in.

The technology stocks I focus on, at least for the past couple of years, are Apple Computer (AAPL), Research in Motion (RIMM), and the Nasdaq 100 ETF (QQQQ).

Apple Computer is the maker of Mac PCs, iPhones, iPods - gadgets with an almost cult-like following. Every time I pass by the Apple store at the mall, it's packed! CEO Steve Jobs and company must be doing something right. Research in Motion (RIMM) is the Canada-based manufacturer of the ubiquitous Blackberry. Finally, the QQQQ is an exchange-traded fund which represents an indexed average of 100 of the top tech companies traded on the Nasdaq stock exchange. It includes AAPL, RIMM, and also Microsoft, Intel, Cisco, Amazon, etc., you get the idea.

The tech sector has been resilient. While these stocks crashed along with everyone else in the financial crisis period of late 2008, they have bounced back reasonably well. This is because they sell products that people can't seem to live without. Apple in particular keeps coming out with new items that customers can't wait to get in line to buy, and the cash keeps coming in. Good new products, healthy consumer demand and cash flowing in are signs of a healthy company.

I find that the premiums for options on tech companies are higher than for most Dow or S&P stocks. Tech companies tend to have wider trading ranges (price fluctuations high to low) and faster price movements. While for stockholders this up and down motion might equate to a stomach churning roller coaster ride, for options traders this translates into richer premiums. If you are a seller of options, you want nice rich, high premiums (remember you want to sell high).

...if it comes to that...and selling puts allows me to buy them at a discount. Since I only do cash-covered puts, there is enough cash reserved to buy the stock should it fall to the strike price. If the stock price falls at or below the strike price at expiration, I take the assignment, purchase the stock, then I turn around and start looking to sell calls against it the following month.

I only sell puts on stocks or ETFs that I am willing to own outright.

When selling puts, I use price and moving average charts to see support levels for the stock. Charts can show where prices have tended to move or stay above for a period of time. I usually try to pinpoint support levels using double bottoms, then choose a strike price that is even one strike below that support level. For example if Apple support is at $200, I will try to sell the $195 put, even though I make a little less premium with the lower strike.

Notice on the chart below how the Apple's price tended to go down to around $190 where the blue line is, but not really below? The wide "W" shape of the chart is a double bottom. Also note the overall general upward pattern of the graph from left to right, a bullish pattern.

Below is an real life example of regular put selling on Apple Computer (most months but not every). I made the example for 5 option contracts just to illustrate how a few hundred bucks, every month or two, can add up.

One of the drawbacks for this strategy is that the cash reserve for 100 or more shares of Apple and other stock is quite large. That money can't be "put to work" elsewhere for the duration. Another downside is that if Apple really takes off, my profit is limited, and I'm kicking myself wishing that I actually owned the stock itself. But for certain market conditions and individual investment situations, put option short selling can deliver satisfactory returns.

Remember that equity options trading involves risk and is not suitable for all investors. This hub and the examples in it are strictly for educational purposes and not intended to be taken as trading advice or recommendations. In other words, I am not a licensed financial adviser or broker, I am just sharing my own experience. So don't go run out and start selling puts without considering your own needs, goals, risk profile, etc!