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Options can not only be used for speculating and hedging but can also be used to earn passive income with certain strategies.
In this video, I go through a practical example of selling eBay put options using Interactive Brokers.
This video is for informational and educational purposes only and should not be construed as financial advice. Options are complex financial instruments and due to leverage can easily lead to financial loss. Seek advice from a professional.
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Investing in options is not just all about hedging and speculating, you can also use
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certain strategies with options to earn some passive income. And in this video I'm going to go through one particular strategy which involves selling puts
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So if that type of content interests you, then please make sure and subscribe to the channel
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I'm trying to get to 1 million subscribers in the next 5 minutes. So first off, let's just set the scene
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So why would anybody want to sell put options in the first place? Well this strategy is particularly suited to somebody who has done some ysis on a stock
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Let's say eBay which we will use as an example through this video. So eBay is currently priced at $52 at the time of me making this video
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So let's say somebody comes along they want to actually invest in eBay and they want to buy 100 shares of eBay
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So they have done a lot of in-depth ysis and all of their models suggest that the fair value price of eBay is actually $45
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so they would only really be happy to invest in eBay if the price dropped to $45
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So rather than just taking the $4,500 and setting it aside and waiting for the right opportunity to buy eBay
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they could earn some passive income and I hate using that word passive while they wait for the price of eBay to drop down to $45 if their ysis was correct
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So that is just who the strategy is focused on but next up just a little bit of basics on options if anybody is not sure
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So obviously for every contracted options, you will have two sides to the contract
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You will have somebody buying the contract and selling the contract. And a put option gives the person who bought the contract a right, but not the obligation
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to sell a certain amount of stock at a predetermined price within the term of the contract
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Put options are basically like insurance contracts for your investments. So let's say you had a load of money invested in a stock and it's currently priced at 100 euros
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You already made a lot of profit from it but you think there could be possibly a bit more upside But you really worried that the price could tank Well you could buy a put option that would give you the right to sell all of your stock at a predetermined price You could buy a put option
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which guarantees that you will be able to sell your stock at at least a value of say 95 euro
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But in order to avail of this type of option you are going to have to pay a premium to the person
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who is selling the put contract. So that is a key bit of information there. The person who is
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actually selling the put contract earns the premiums. So let's take that now and go back to
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our eBay example from earlier on. So the current price of eBay is $52 and I want to buy if the
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price drops to $45. As part of the investors ytics they think that the price is likely
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to drop to $45 within the next five months. So before the quarter three earnings call in 2022
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so the best thing that they can do then is sell a put contract with a strike price of $45 that
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expires in September here is that exact contract on interactive brokers so as you can see here
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there's an ask price for this contract of $2.45 and one thing you must remember when you are
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trading with options they are sold in lots of 100 so you will have to multiply the price of
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everything by 100. So basically by selling this put option with a strike price of $45 that expires
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in September I will get a premium of $245 less a few small fees. If you calculate that $245
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as the percentage of the cash you have set aside of $4,500 because you want to buy 100 shares of
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eBay at $45, that works out to a return of 5.4%. That's not too bad of a return over a four or five
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month period. And if you annualize that return, then it goes up to 13%. Generally, the more
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volatile the stock is the higher the premiums that you can get by selling put options So volatility is very good when it comes to selling options but not great when you owning stocks So I hope
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everybody is still with me. I'm going to go through three different scenarios now of what
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could possibly happen after you sell your put option. Scenario one, the price of eBay actually
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remains at $52. In this case the option will never be exercised by the person who bought it because
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They're obviously not going to want to sell their eBay stock at $45 when they can sell it on the open market for $52
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So the options contract is completely out of the money. So what happens then basically is the option expires worthless
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You get to keep your premium of $245. But obviously the stock price hasn't dropped to where you wanted it to go
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So you haven't actually got the chance to buy any eBay at $45
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so at this point if you still have high conviction you could sell another put option and earn more
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passive income scenario two the eBay price actually rises to $56 again this option is
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completely out of the money and worthless and the person who bought the option is not going to
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exercise it so again you're going to earn your premium but you won't obviously have got the
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opportunity to buy eBay again at $45 and maybe you would probably be worried that oh I missed out on
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the chance to buy it when it was at $52 but again if you still believe your ysis and you have
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high conviction that it is going to drop eventually to $45 you could sell another put option again and
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earn more passive income. You are basically getting paid to wait until the stock goes to the price
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that you want it to go to. Okay so scenario number three in this scenario the eBay price actually
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drops to $43. The person who bought the put option is obviously going to exercise their option now
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because they can sell it at a price of $45 when it is only worth $43 on the market
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You are the person on the other side of the contract so you will then have to buy the 100 eBay stocks at a price of and that was the price you wanted to buy them all along
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The only thing is if you never sold the put option in the first place then you could actually have went and bought eBay at a price of $43
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But when you add in the $245 premium you have earned into the equation you're actually still better off by $45
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The risk really is that the price would drop much further than $43
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dollars in that situation you would probably be kicking yourself for selling the put option because
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you could have bought ebay at a much much lower price but you have to go back to the mindset you
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had when you first did your ysis you believe that 45 was a fair price so you probably will be
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still happy to get in at a price of 45 dollars so what are the other pitfalls of selling put options
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well firstly the price of the stock is actually very important because that will dictate how much
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cash you have to set aside to cover the position. For example if you are selling one put option on
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Tesla the Tesla price is around $900 at the moment so you would need to have $90,000 set aside and
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most people obviously will not have that. So this strategy is probably limited to stocks which have
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a low stock price. Another pitfall is obviously having to hold that cash on the side in the first
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place. I know you are still earning a premium for doing it you are not going to be earning any
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dividend income and the value of that money is going to be affected by any rise in inflation
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and possibly if you are in that situation where you think a stock is overvalued and you're waiting
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around to buy it at a lower price maybe you would be better off trying to actually short the stock
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than trying to profit from its decrease but anyway that is my video on selling put options to try and
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earn some passive income it was a hard one to try and explain in the video so i hope everybody
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understood everything i was trying to get across if anybody has any questions please let me know
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down in the comment section and i will try and answer them thanks very much for watching and
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hopefully i will see you guys in the next one
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