If you have ever placed any bets, you would know that the person who wins most of the time is the bookmaker. Do you know that you too can be a "bookmaker" in the options market by writing put options? Not only can you play "bookmaker" by writing put options, you are actually also playing "insurer" where you get paid a premium for doing so no matter how things work out! Let me show you how!
If you have ever traded options, you would have bought call options if you think a stock is going up and bought put options if you think a stock is going down. You would also have been frustrated over the fact that these options you bought decay in value every day the stock doesn't move and eventually expire worthless if the stock doesn't move by expiration. This phenomenon is known as Time Decay.
Time decay is the number one enemy of traders betting using stock options. When you buy options, you pay a premium for owning the contract. This premium reduces as expiration draws nearer and if your bet doesn't work out, you lose the bet and the premium that you paid. Now, who is making all that money that you see decaying daily in your trading account? The person who sold you those options! He is your Bookmaker in that trade! That made options trading sound like a lottery contest doesn't it?
This premium is known as the extrinsic value in options trading and is what you pay the person who sold you the contract for the risk that person take.
Now, since in a conventional bet, the bookmaker or the insurer makes the most money, won't you want to experience how it is like to be in their position? Yes, you could do that in options trading by writing options instead of buying options! Instead of watching time decay reducing the value of your position in pain, you will now see a grin grow across your face. Yes, time decay becomes your friend now.
If the person who placed the "bet" loses and the stock didn't move as that person predicted, you get to keep the "bet" money as "bookmaker". See how this works? Now, do you see more winners or losers around you in a bet? Would you rather be bookmaker or the "gambler"? Now, what about risk?
There are people who win in bets aren't there? Won't we have lost money being bookmaker if people win?
That is why there are two golden rules to stick to when playing bookmaker by writing options. First of all, you never play bookmaker to only one trade. You do know what most people lose their bets but there are always a few winners, so you should always diversify and write options on several trades, not just one. Secondly, you always write put options, not call options. Now, this second rule requires a bit more elaboration.
Why do you only write (this means sell in options trading) put options? When you write put options, you are giving the person buying those put options the right to sell the stocks to you at a fixed price. In simpler terms, you write put options to people who are betting that the stock is going to go down. Now, unless you are reading this in one of those once-in-ten-years recession bear markets, most stocks go up. This automatically puts the odds of winning against the person buying your put options. Secondly, even if the person who buys your put options wins and sells you the stock at the strike price, you would still end up with stocks which you could hold for the longer term and benefit from its dividends and future capital appreciation! Let's say you write put options on your favorite stocks, if you win, you win money and if you "lose", you get to hold your favorite stocks at a price which you chose to when you write the put options and gets paid dividends (so make sure it's a dividend paying stock)! Isn't that a win-win situation? Yes, this is why writing put options is such a popular options trading approach recently.
Now, you may ask, what if you do not have the money to buy the stocks from the person whom you sold the put options? Well, your broker would have made sure that you have the money to do so in the first place before allowing you to write the put options. This is known as options margin.
To improve your chances of winning at writing put options, you should also write only out of the money put options. This means writing put options with strike price lower than the prevailing stock price. The lower the strike price, the more the stock has to drop for the person who bought your put options to win, hence the lower the risk for you. On the other hand, the lower the risk, the lower the profits become for you. This is the same bookmaking principle everywhere.
But, before you go out there and start to play bookmaker by writing put options, you must have a comprehensive knowledge of put options first! Read our tutorial on Put Options at website .
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