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Selling puts/Short Puts Questions.
From what I have read thru so many blogs and sites about selling puts....
....If the stock price drop below your strike price you are required to pay and buy 100 shares of that stock, and minus the premium. I've been selling puts for many months, and never have I ever experienced when price dropped into ITM, and below my strike price. I was always able to collect the premium or at least cover the puts at a small profit.
Will my broker do the assignment of 100 shares automatically if the shares drop below my strike price? Let's say if my expiration date is 30 days away, and stock price already drop below my strike price the first 2 days. Will it assign? Or does it assign on the day of expiration? If it only allow us to buy the shares at expiration date, does that mean even if the stock price drop to $0.01 cent, I'd still have to buy the 100 shares at the strike price minus premium?
Also does that mean the 100 shares will only get assigned if the "closing price" on Friday is below the strike price? So I get the shares after hour on Friday?
The seller of puts has an obligation to buy the shares at the strike price any time the buyer of the puts decide to exercise them. While early exercise is a possibility it doesn't happen that often...and if it does it doesn't change your risk. While it may change your capital requirements to maintain the position you can sell the shares back out any time your brokerage is open.
The reason it doesn't happen early very often, even if you are far in the money, is that the options still have "extrinsic" value. The put buyer would be sacrificing this value to sell the shares at that price. It would make more sense for them to just sell the puts. To calculate the extrinsic value of an in the money put simply subtract the strike value from the price the stock is trading for...the remaining number is the extrinsic value...or time value. (or simply look at the value of the corresponding call...which, since it is out of the money , has ONLY extrinsic value and will be trading at or near the extrinsic value of the put.) If the options are very liquid and efficiently traded these values will be nearly the same.
The risk for selling a put is actually less than buying the shares as your break even is the strike MINUS credit collected....and the capital requirements are generally less. Also as you have already noticed it actually improves your over all profit if you take profits before expiration...thus freeing up the capital to re-establish another position. When selling options you not only become profitable if price moves in your favor but you also get ahead as time decays and/or volatility contracts. Selling options as close to 45 days to expiration when Implied Volatility is near or above 50% increases your chances of success. Puts can also be rolled into another expiration...especially useful if you are nearing expiration and the put is not yet profitable enough or being tested.
Only trade very liquid options with a lot of open interest. For starters if the bid/ask is more than a nickle wide...stay out. Also being short a put allows you to sell a call without any additional capital requirements...creating a "strangle"....this also adds to the credit received thus improving your break-even further.
