John Jagerson

Selling Short Puts vs. Covered Calls

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Selling or writing options is one of the most effective strategies available to options traders.

Among the advantages is the fact that time value, over the length of the option's life, melts away in your favor. This happens because the closer you get to expiration, the less time the option has to reach a profitable price, making it less valuable to buyers.

In this lesson, we will cover two option selling strategies -- selling puts and covered calls -- from a risk and reward perspective, and learn how they relate to other strategies you are already familiar with.

Did you know that selling a put has the same risk profile as a covered call? That surprises most traders when they first begin to understand how this trade works.

In fact, over the long term, selling a put can be as effective as a covered call from a volatility perspective. Plus, it can reduce trading costs. This is because a short put only has one position (the put) rather than the two positions (the long stock and short call) involved in a covered call. (See Selling Puts vs. Covered Calls -- Which is Better?)

Selling a put is essentially a bullish strategy. It's bullish because you are the seller and are hoping to sell the put now for a high price, and then let it expire worthless or buy it back later for a lower price after the underlying stock has risen.

If stock prices rise, a put will decline in value and, ultimately, any put that expires out of the money is worthless. That is a great position to be in as the put seller, because you keep the premium, with no obligation to deliver any stock.

Let's discuss these strategies by contrasting the two trades on a single stock.