Dear readers,

I would like to thank all readers of marketcalls for your mails. As I was busy with my new sub-broker, I could not update here.   Most retail traders buy put option to make money in falling stock or index.  Have you ever wondered who is selling the put options that you are buying? Most likely, it is another trader who has the opposite outlook for the stock (bullish).

For example, when you buy a stock put option you think the price of a stock is going to plunge. Sellers of a put option don’t think it will, Or do they? A trader who selling put options may have another intention in mind. They might be selling put options with the purpose of buying stocks at inexpensive prices and they are collecting income while they stay calm to do this.

When you buy a put you are buying the right to sell a stock at the strike price of the put anytime before the option expires. You have the right to do this even if the stock price falls to zero.  Who is going to buy the stock at inexpensive price? It is the same trader who sold the put option.

As you very well know, blue-chips don’t fall much even in the worst bear run, if they fall, they are likely to bounce back as market bounces back from fall. Even the strongest blue chip stocks undergo periods of weakness. This is when smart investors jump in and sell puts. The key is to only sell puts at strike prices at which you want to buy the stock. And as with buying options, you can earn this return without ever having to actually buy the stock.

Here’s a specific example of how that actually works.

I recommended selling (short) RELIANCE 960 put @Rs.10(LTP as on 30/04/10), (Rs.3000 premium) using this kind of options technique is called “naked put write.” When you write a naked put you are compelled to buy 300 reliance shares at the option strike price (i.e.Rs.960), regardless of how low the reliance price might actually be when the option expires.

Here are the possible outcomes of the position:

If Reliance was above 960 at May 27, 2010 (expiration) the put would expire worthless. You will have earned Rs.10 per contract or Rs.3000 per lot.

If Reliance was below 960 at expiration you would have to buy 300 shares of the Reliance at Rs.960 per share. Because of this risk of potential stock ownership, when you write puts you must set aside enough capital to cover the stock purchase should the necessity arise. More important, you must also want to buy the stock.

Though most stock brokers will try to tell you otherwise, writing puts to buy stocks is actually a conservative option-writing strategy, as long as you keep up the control to only write puts on stocks you want to buy, at strike prices at which you want to buy them, and don’t write too many puts at one time (limit to 1 or 2 lots). Buying put options is just one way to profit if stocks start taking on a bearish movement.

Selling or writing calls is another.  Writing (selling) covered calls in one of the most basic and also the safest of all option strategies. You can generate additional income from stocks that you own, and this income helps hedge against the risk of owning the stocks.

But in order to write a covered call, you must first own at least 300 shares of the underlying stock (example Reliance in this case).

Narendar Rathod, Options strategist, www.AssuredGain.com