Hey GKT
This blog post is aimed to answer the question, “How do I start trading options?” By no means is it the only place you can start or even the best place to start. Even if you’ve already made a few trades, I hope this post will give you a new idea.
How to Start Trading Options
The easiest way to get started trading options is by selling a put option. Literally, just one put.
With that, I could almost write a nice farewell paragraph and call this post written. BUT, at GKT we are interested in teaching you and helping you understand the hows and whys behind making trades. This kind of knowledge can help create a never-ending stream of income that takes a few minutes of “work.”
Some of you may be skeptical of why we do it for free or wonder, what is the catch? The “catch,” if you want to call it that, is that we hope you will be excited to post your trades in our free Discord. We all look at stocks differently, so when you post a trade I may have missed, you allow me to ALSO profit by your “work.” Since I already post my trades there, we will build each other up!
Alright enough about that…
Guidelines to Selling Put Options
Understand your risk
Develop a plan around the risk you are willing to take
Evaluate the options chain
Determine your “exit plan”
Place the trade
Follow your plan
Risks to Selling Put Options
When you sell a put, you agree to buy the stock at the price where you sold your put in the event the stock’s price drops below that level before the expiration date.
All options are effectively "contracts" between buyers and sellers. Often times an option will be called a "contract."
Example:
AAPL stock is currently trading at $84. You decide to sell a put at the $80 strike price which expires in July. For doing this “work,” you “earn” the premium associated with that option. Let’s say it is $1 per contract. Remember all option contracts are for 100 shares, so in this example you would earn $100 real dollars.
If on the expiration date in July, AAPL is at some price greater than $80, you get to keep all the $100 you earned, and the option expires worthless. This follows the same concept as a coupon that you could have used at a grocery store, but you forgot to use it before it expired.
If on the expiration date in July, AAPL is at some price LESS than $80, you will be forced to buy 100 shares of AAPL at $80, which will cost you $8,000. But remember you earned $100, so you really only spent $7,900.
In short, the biggest risk to selling a put is the stock price falling BELOW the price where you sold your put which results in you buying 100 shares of that stock.
Reducing Risks when Selling Puts
Here are some ways to reduce your risk when you sell a put
Make sure you can afford to buy the 100 shares of stock
In essence, this means to trade within your budget. If you are car shopping, you wouldn’t walk into an exotic car dealership if your budget only affords a 1988 Ford Escort (my first car!).
With this in mind, figure out how much you, in a WORST CASE SCENARIO, are willing to risk on any one trade. If you want to and can afford to trade TSLA, go for it! But don’t trade TSLA on a Ford Escort budget. Trade stocks whose price make sense for your account size.
You don’t want any one trade gone wrong to abruptly end your trading career. There are things like “margin” which allow you to risk more money than you have in your account. If you are new to trading, pretend like it doesn’t exist. If you don’t have the cash, don’t make the trade.
Sell puts in companies that you understand and don’t think are going to go bankrupt any time soon.
This rule reduces risk even further because in order for max loss to occur, the stock would have to go to 0. Companies like KO (Coca-Cola) that have been around for 100+ years are UNLIKELY to go out of business. But just because they are a big name doesn’t mean that your 100% safe. Remember Kodak, RadioShack, and Sears? If not… these were once household names that went bankrupt. If you don’t believe me, ask someone with some grey hair.
When you first start selling puts, choose stocks that you at least have a general understanding of how they make money. "KO sells soft drinks" is about the level of understanding you need. If you can’t summarize a company’s business in one short sentence, don’t trade it until you know what you’re doing.
Use support lines and major moving averages to your advantage! Check out this article on Moving Averages here for full details on these concepts
This rule comes into play because you don’t want to sell a put on a stock that has nothing between it’s current price and zero, like the example of CHWY above. If the stock’s price looks like an arrow falling back to Earth, take your business elsewhere. There is no need to force anything when a stock's chart looks like this no matter how tempting the premium may be.
In general, I like to sell puts below levels of support. Support levels are places where the stock’s price stopped going down in the past. Long-term moving averages like the 100 and 200 SMA also tend to be good support. I try to sell puts that have a lot of support areas above my strike price. The example I've used does NOT meet those criteria because the 80 strike is above the 50EMA (yellow), the 100 and 200 SMA (blue and red, respectively), and above an area of previous support.
Evaluating an Options Chain
This topic in itself can be a whole series of articles. However, this article is going to keep things simple.
The first step is to determine what price are you willing to own that stock. Determine this by looking at the stock’s chart and use the support lines as your guide.
Once you’ve done that, then you can open up the options chain and ask yourself these questions:
How far away from the current price is your “willing to own it” price?
What is the delta of your “willing to own it” price?
How much premium are you getting?
There is no hard and fast rule to go with these questions. You just need to be comfortable with the answers. For instance, XYZ’s price is currently $100. If you sell a $99 put, there is a much greater chance of you having to buy shares at $99 than if you sold one at $90 or $80. The trade off is that you make more money (also known as premium) when you sell puts closer to the current price.
Again, no firm rule on this, but I also like to sell around the 0.16 delta and will go between 0.10 and 0.25 delta for most of my trades. You can find the delta of any strike by looking on your option chain. Think of delta as the probability of a stock’s price falling below that level. The lower the delta, the lower the probability. The higher the delta, the higher the probability.
At GKT our general rule of thumb is that we try to collect 1% of the strike price in premium for every 30 days of time you sell. If you are collecting more than 2% premium, then you should really understand what you are doing and why you are doing it.
Example:
XYZ is at $100, you look to sell a $90 put that expires 30 days away and that put sale is worth $0.90.
ABC is at $100, you look to sell a $90 put that expires 45 days away and that put is worth $1.35.
Both of these would meet the 1% target outlined above. You can always go less than 1% but I generally think that the premium doesn’t compensate for the risk.
Real World Example:
Exit Plan when Selling Puts
An exit plan should cover both winning and losing trades! The plan for winning trades is very simple and honestly boring.
Exit winning trades at 50% of the premium you received. There is a lot of math and research that supports why this is optimal and is covered in depth here and over at tastytrade. In fact, I put in my closing order IMMEDIATELY after I enter the trade as a GTC (good till cancelled) order. You’ll quickly come to love getting these notifications that a trade closes while you are away from a computer enjoying life.
When a trade goes wrong you have a couple options. A trade going wrong means that the stock price falls and the price touches or goes below the price you sold the put. There is no “right” way to handle that event. If you sell enough puts, this WILL eventually happen to you too. Sometimes I go ahead and buy the shares because I like the company at that price. Other times I will buy back the put for a loss and sell a second put further out in time, and even at a lower strike price. Ideally I’ll do this and will collect more money than I paid to close the opening put. This is what is meant by “rolling” an option.
Example:
I sold XYZ put at $90 for $0.90 initially. The stock price went down and that put costs me $1.90 to close it. I look 30 days away and see that the $85 put is trading for $2.00 and decide to sell it. I now have sold an 85 put for a total credit of $1.00. ($0.90 initial credit - $1.90 cost to close + $2.00 credit on 85 put = $1.00)
If this is confusing, join our discord and you can see us making these types of decisions all the time. We also gladly explain our reasoning behind what we do. You’ll even find examples where several of us are in the same trade but choose to manage differently based on what we think may happen next.
We also manage our put sales at 21 days to expiration (DTE). Again, there is a lot of math and research behind this. If we are profitable at 21 DTE, I typically will exit the trade even if it hasn’t reached 50% profit yet. We also use 21DTE as our deadline to roll out losers or just cut our losses and exit the position entirely.
The important part is that you know what you plan on doing BEFORE you enter the trade. Make sure to know your plan for in the event that the stock’s price goes higher or lower.
Sell the Put
Once you’ve done everything above you have to do the easiest part of the whole thing, sell the put. Literally takes a few clicks of a mouse and you’ve done it. Now sit back and let the trade happen. These trades take a couple weeks sometimes, so don’t get in a rush. Just relax. Set up your 50% closing order and go enjoy living! Mark your calendar for 21 DTE and set some alerts on your chart if you want, but most importantly you gotta step away from the computer and wait.
Follow your plan
This is easiest with winners as your trade closes automatically for 50% profit. As outlined above, the losing trades come with the emotions of loss and anxiety. That’s why we think of our plan before we get into the trade. In fact, you should write out your plan and reference it often. As tempting as it may be, avoid straying from your plan. You made it in a clear state of mind so don’t go doubting it when you’re stressed.
We all have losing trades. Managing your losing trades well is what separates successful trades from bankrupt traders.
Putting it all together
Selling puts is a fundamental option trading strategy that even beginners can learn and execute with high levels of success. Keep these principles in mind and you’re ready to get started.
Understand the risk you’re taking and make sure you’re okay with it. Know your budget!
Develop a plan around the risk you are willing to take.
Evaluate the options chain. Target 1-2% of the strike price in premium for every 30 days of time
Determine your “exit plan.” General guidance of 50% of premium collected for winners and otherwise manage no later than 21 DTE.
Place the trade with a few clicks of a mouse.
Follow your plan. Don’t let emotions change your plan!
We sell puts daily at GKT. In fact, we like the strategy so much that we've written more than a couple blog posts on it.
If you want some articles that walk you through actual trades, check these out.
Join our Discord and trade with us. It is free to join and you’ll see exactly how, when, and why we sell puts and also how we manage our trades.
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