Going short by writing a put is generally considered more risky than going long since you're obligated to honor your side of the contract should the holder decide to exercise. In general, you would choose this strategy because you believe the stock's price will rise above the strike price, leaving the option without any value at expiration and you with the premium.
A more conservative reason to sell a put is if you have a target price at which you'd like to buy shares of a stock. Should the option be exercised, you'll be forced to pay for the stock. The premium you received will reduce your net price paid on those shares.
For example, say you write a put with a strike price of $35 and a premium of $2. If the stock's price drops to $31, you'll likely be assigned the option. You'll have to pay $3,500 for the shares, but the $200 you received at the outset means your net price for the shares is $3,300, or $33 per share. If the stock's price rises again in the future, you could realize considerable gains.
Short Put Graph View Graphic
In the graph shown here, the vertical (Y-axis) represents profit and loss, while the horizontal (X-axis) shows the price of the underlying stock. The blue line shows your potential profit or loss given the price of the underlying.
One way to help ensure you have the money available should a put option be exercised is by writing a cash-secured put. When you sell the put option, you simultaneously set money aside. Securing your put with cash ensures you'll have the money if you must buy the shares and also helps make certain that you don't commit yourself to more options contracts than you can afford.
Examples exclude transaction costs and tax considerations.
Options involve risk and are not suitable for all investors. Detailed information on our policies and the risks associated with options can be found in Scottrade's Options Application and Agreement, Brokerage Account Agreement, and Characteristics and Risks of Standardized Options (available at your local Scottrade branch office or from the Options Clearing Corporation at 1-888-OPTIONS or by visiting www.888options.com). All option accounts require prior approval by Scottrade. Market volatility, volume, and system availability may impact account access and trade execution. Supporting documentation for any claims will be supplied upon request.