Lee Lowell wrote a great book on option trading “Get Rich with Options: Four Winning Strategies Straight from the Exchange Floor“. He is one of America’s leading options professionals. Lee spent six years in the options market as a market maker on the floor of the New York Mercantile Exchange (NYMEX) in New York City. He has his own office-based trading firm where he trades commodity, stock & index options on a daily basis.
One of the strategy I like from the book is selling naked puts. Naked put is an option put where the option writer does not have a position in the underlying stock. This strategy is used when you want to buy stock, but you think the price is too high. By writing a put, you will get a premium. If the stock price rise, you will keep the premium, but if the stock drop, you can buy the stock at strike price.
You can see that the potential profit is limited to the option premium, and the potential loss is unlimited if the stock falls all the way to zero. So this strategy is very dangerous if you didn’t know what you are doing.
The key of this strategy is very simple. A smart put-option seller will only sell put option contracts at a strike prices at which you would like to buy the stock. The secret is to pick a stock that you would like to own at a cheaper price than it is now. Here’s what I do, I look for stocks that just rise because of good earning result. Since the price has rise, I want to buy it at lower price, so I just write a put option at lower strike price and wait until it expires.