Everything does not work
Instead, it is possible to profit far more than 50% of the time, whether the security goes up, sideways, or even a little bit down, by selling an out-of-the-money (OTM) put, ie, one whose exercise (strike) price is less than the currrent price of the security. You collect the premium up front, and you keep it if the security price is anywhere above the strike price at expiration, which happens more than 50% of the time.
However, if the security ends up below the strike price, you either have to buy the security for more than you can sell it for, or pay the difference. If the security crashes, you may have to pay a great deal. Even if you have a stop loss order, it may not be executed in a rapid crash. Once your stop loss is breached, it becomes a market order, and may be executed far below where you expected to get out.
One way to protect against this unlimited potential liability is to buy a put with a strike price a few dollars below the one you sold. Then, even if the security price goes to zero, your maximum liability is the difference between the strike prices of your long and short puts.
That's called a "put spread", and that's the rationale for selling ("writing") one. To make money most of the time, and limit your loss the rest of the time. And you're "selling" it because the transaction brings money into your account.
To be more specific, this program helps you choose OTM Bull Credit Put Spreads:
"OTM" because both strike prices are less than the stock price when you do the trade.
"Bull" because it makes money on the upside, and loses on the downside.
"Credit" because your account is credited with the difference in premiums, not debited. That's because you always Sell the put with the higher strike (and premium), and buy the cheaper put with the lower strike.
"Put" because both sides of the hedge are puts, and
"Spread" because there's a spread in the strike prices.
Since the market has a long-term secular bull trend, and bull markets tend to be longer and less volatile than bear markets, and calls generally have lower premiums than puts, we do not recommend and have not provided a corresponding bear call spread program. If you really want to trade the bear side, you might use this program to sell bull put spreads on inverse ETFs.
1. Which security should you write the spread on?
Since you don't want the price to come down to your short put's strike price, you want a security with low volatility. You can free yourself of the possibility of many sorts of nasty surprises by avoiding individual stocks and sticking with Exchange Traded Funds (ETFs). You thereby avoid sudden price drops due to bad earnings reports, clinical trial failures, patent rejections, lawsuits, CEOs wrapping their Jaguars around trees, etc.
The downside is that lower volatility means lower premiums, so more spread contracts are required to make your desired credit point.
2. How far out in time should your Expiration date be?
In general, closer expiration is better because premiums fall fastest at the end of their life. A one week option will generally be more than 1/4 the price of a 4 week option, so you would make more by selling 4 1-week option instead of 1 4-week option.
The downside is that you will have 4 transaction fees instead of one, so the benefit will vary with premium price.
A shorter time is also better in that it gives less exposure to major price moves.
The downside of shorter options again is that premiums are lower than those of longer ones
3. How far from the stock price should you place your short put?
Closer to the money you will get higher premiums, but also be more likely to lose because the stock price is more likely to breach your strike price. Further from the money is safer, but the premiums are lower, so you may need more contracts to make your profit point, increasing your possible loss.
If you're confident in your ability to call the direction of a security, You could place your short put very close to the stock price. But, if you were that confident, why not just buy the stock? Because you have no Right to be confident about what the market will do!
4. How far below the short strike should you place your long strike?
The closer the two strikes (the "narrower" the spread) the less your maximum loss, but the less your credit, so again, you may need to sell more spreads, increasing your maximum loss.
With all these countervailing requirements, and hundreds of possible hedge combinations, how can you possibly choose a good one, much less the best one? Aha! Funny you should ask!
The "Select Bull Put Spread" program (SBPS) does all the hard work for you.
You still need to pick the ETF (or stock, if you insist) you want analyzed.
Enter a security symbol (e.g. SPY) and click Submit button.
Please wait for a few moments while SBPS downloads all the necessary data and select the expiry dates you're interested in. You can choose to show only options with volume equal or greater than a certain number, which you can define in a text field right below the table.
Click "DO THE PLOT" button when you're ready and you'll be presented with a couple of graphs.
The second graph actually contains a mass of information and allows you to filter the spreads by a number of criteria.
The default graph axes are probability of loss and expected profit, but you can change the axes and scale in the filtering table.