First Scenario : An investor that is bullish on the stock can sell a put and collect the premium. The maximum profit from this occurs when the price of the stock stays above the strike price. The break even point for the investor and trader is occurs at (strike price - premium that was collected.
In the above image, the strike price is $25.00 and the option premium is $5.00. So the break even point is therefore $20.00. Basically the profit decreases at the strike price. As the stock price falls as indicated in the above diagram the amount of profit decreases.
If an investor wants to invest in a stock but wants to buy it had a cheaper price. They can make money why they wait. For example, if Johnson and Johnson (JNJ) is trading at $50.00 currently and I want to buy it at $45.00. An investor can sell a deep out of the money put and collect the premium. So if the stock stays above $45.00, the investor will make maximum profit which is the premium minus the commission. If JNJ falls below $45.00, the investor will buy the stock at the strike price. So the investor wins by buying the stock at a cheaper price which means their yield on cost will be higher as the stock is purchase at a lower price.
An investor should only sell naked puts when they are willing to own the stock in question. Naked means the investor does not own the underlying stock. An investor needs to get permission to sell puts from their broker.
This is a high risk as the stock can go to zero theoretically.
My next post will go into another way to make money besides dividends.
Photo Credit : mozcool.com