I disagree with this notion. While there can be added risk, I don't consider the strategy to be all that bad, or overly risky. In essence, the seller is paid money, (called a premium), for accepting the obligation to buy a specific stock, at a specific price, on a specific day. That doesn't seem all that bad, right?
Although there are some terrible ways to go about using short puts, in many ways it can be a sound strategy. Let's look at Ford for example. We think the stock is eventually going to go higher. The stock has already pulled back about 10% from its monthly highs to its recent low.
Shorting puts as an entry into a long common stock position is a way of saying, "We've had a decent pullback and I'm willing to own the stock on a continued pullback, but I don't want to miss a rally."
That's exactly the situation we have here. The stock has had a decent pullback, and has now caught our attention. But what would stop Ford from dropping another $1, or more? Nothing, really. The same could be said by asking the inverse; what would stop Ford from going up a $1 per share?So to play the bounce or buy shares at a lower price, selling puts becomes an adequate solution. Let's use the November expiration, nearly three-months away. I picked the $15 strike, meaning I will be assigned 100 shares for each put option sold short if the stock closes below $15 per share on November expiration. In addition to shorting the $15 puts, I bought the $10 puts for 3 cents. The reason I did this was twofold: To lower the margin requirements and raise the return on invested capital.
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