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What are Put Writing Strategies Learn in detail

14 Jun 2023

Introduction

When you sell derivatives contracts, you agree to buy an underlying security at a predetermined strike price and expiration date. If you are seeking to speculate the price movements or hedge against market fluctuations, writing a put option can be a powerful tool. 

However, doing so also requires some strategies. Here we'll learn about these strategies to help navigate the dynamic of options trading. So, read on to expand your knowledge and make informed investment decisions.

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What are put writing strategies?

Some of the best put-writing strategies you can implement to take advantage of market movements are as follows:

Short Put

In options trading, a short put occurs when a trader sells a put option. The writer (short) receives the premium but is obligated to purchase the underlying stock if the buyer exercises the option. This strategy, also called an uncovered or named put, has a limited profit potential equal to the premium received. However, the short put holder may face significant losses if the underlying price falls below the strike price before expiration or exercise.

Put Ratio Backspread

The put ratio backspread is another options trading strategy. It combines short and long and puts in a specific ratio. Its profitability depends on the underlying stock’s volatility. Depending on its structure this strategy offers either unlimited profit potential with limited loss or limited profit potential with the risk of unlimited loss. Generally, the ratio of long to short puts in a put ratio backspread is 2:1, 3:2, or 3:1.

Short Put Ladder

A short put ladder is an advanced options strategy that expands upon the Bull Put spread by adding a lower strike put option. This additional strike has unlimited rewards if the underlying asset experiences a significant downward movement. This strategy is best employed when anticipating substantial downside movement in the asset and can be profitable when the stock breaks the lower strike price. It is also suitable when expecting a rise in implied volatility after an unexpected fall.

Short Put Butterfly

The butterfly options strategy is a market-neutral approach involving multiple legs and offering limited profit-and-loss potential. This reliable and risk-defined strategy combines two spreads, which incorporate long and short positions for put and call options. A short put butterfly strategy is formed by selling an out-of-the-money put option, buying two at-the-money put options, and selling in-the-money put options. It is a four-legged strategy using three options strikes, thereby combining elements of both long and short put option spreads.

Bull Put Spread

The bull put spread is a variant of the put writing strategy. Here, an options investor writes a put to generate premium income and potentially acquire the stock at a discounted price. However, put writing carries the risk of having to buy the stock at the put strike price. This can lead to potentially significant losses if the stock drops below the strike price. The bull put spread mitigates this risk by simultaneously purchasing a put at a lower price. Thereby, reducing the net premium received but also minimising the risk associated with the short put position.

Bear Put Spread

The bear put spread is an effective strategy for investors with a slightly bearish outlook. It entails buying a put option while simultaneously selling another put option with a slightly lower strike price. Both types of transactions involve the same underlying security and expiration date. The strike price difference depends on the desired level of aggressiveness. The total profit in this strategy equals the difference between the two strikes, minus the total options premium paid.

Conclusion

When exploring new put writing strategies, initial losses are possible. It is crucial to learn from these errors/losses. This way, you can improve in subsequent attempts. Seasoned options traders recommend employing stop-loss orders to limit significant losses in case of unexpected market movements. It is advised to practise these trades on paper before committing actual capital. If you want to become a skilled options trader, it is essential to embrace a mindset of continuous learning and adaptation.

 

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