When selling puts and creating bull put spreads, here are some basic guidelines to help ensure your profits will keep rolling in.

1)      Seek your broker’s advice.

2)      Understand your margin requirements.

3)      Know where you plan to exit before entering the trade.

4)      Place GTC close orders.

5)      Choose a conservative or aggressive strategy and know why you choose it.

6)      You must like the stock at your adjusted price.

Seek your broker’s advice:  This one is pretty self-explanatory.

Understand your margin requirements:  The S.E.C. initiates a margin requirement for all naked (uncovered) options.  This margin requirement is roughly 30% of the value of the strike price (your liability) and will increase or decrease with the movement of the stock.  Different brokerage houses usually manipulate the requirements for their own needs but are not allowed to go under the S.E.C. requirements.  It is typical for a brokerage house to tie up 20% of he value of the strike price sold plus tie up the premium you received when selling the put to come up with the 30% margin needed for the trade.  A typical margin play would look something like this: 

AOL at 50.00 and you sell 10 contracts of the 50 put for 5.00

50.00 strike price X 20% = 10.00 + the 5.00 premium = 15.00 per share. 

1000 shares would tie up 15,000.00 in margin.

If the value of the stock drops by 2.00 on 10 contracts then you are now responsible for an additional 2,000.00 X 30% or 600.00 of margin.  If the stock continues to drop another 3.00 on your 10 contracts then you are now responsible for an additional 3,000.00 X 30% or 900.00 of margin.  This also works in reverse if the stock moves up in price.

It is always a good idea to leave extra margin in your account to avoid a margin call should your positions move against you.

Know where you plan to exit before entering he trade:  Before you place a call to your broker, know what it is that you want from the trade.  If you sell a naked put on AOL at the 50.00 strike price, with a support level at 47.00, and take in 4.00 in premiums what will you do if the stock moves significantly up or down?  If the stock moves up and your premium drops, you could always buy back your option to close your position and pocket the profits.  Or another option would be to roll into a put spread and buy the 45.00 put as insurance in case the stock decides to come back down.  This will also free up some of your margin.  With a cost basis of 46.00 (50.00 - 4.00 premium) and a support level at 47.00, what will you do if the stock decides to drop?  If the stock drops to 47.00 and holds on the support line you will still end up profitable with a 46.00 cost basis.  If the stock drops through 47.00 it is probably a good idea to close out your position and wait for a turnaround before entering back into the stock.  This can be done a couple different ways.

1)      After your initial sell to open position where you sold the option premium for 4.00 you can place a buy to close stop loss at a limit of 6.00.  A put option increases in value as the stock drops.  When the option price hits 6.00 your standing order will be sent to the exchange allowing you to close your position (see your broker for details between stop loss limit and stop loss market).

2)      A second option would be to place a “buy to close AOL 50 put, market, stop on stock @ 46.00.”  If AOL breaks the 47.00 support and hits 46.00, an order will be sent to the exchange buying back to close the AOL 50.00 put at the market price.

Place GTC close orders:  Use any of he above the methods to accomplish this.  Do not try to ring out every last cent from a trade.  If you sold a premium for 6.00 don’t be afraid to place a GTC to buy to close at 1.00.  This will also free up your margin so that you may use it on another trade.  

Choose an aggressive or conservative strategy and know why you chose it:  If you are playing an upcoming news event (earnings or split) you might trade aggressively selling an in the money put (higher strike price) with the sole intention of buying to close the position BEFORE the actual event.  If you are trading conservatively then it is always a good idea to sell a put BELOW the current support line.  The idea is that if your stock drops it should hold on the support line leaving you some profits even though the stock went down in price.  This will decrease your rate of return but should keep you with a rate of return. 

You must like the stock at the adjusted price:  It would be nice if most of us could accurately predict what was going to happen on every stock in every situation but since that has so far been unattainable it is a good idea to like your stock at the adjusted cost basis i.e. selling the 50.00 put for 4.00 leaves you with an adjusted cost basis of 46.00.  It may not happen to you often but there is always the chance you could end up being assigned the stock.  If you do not like your stock at the 46.00 level, you probably should not sell the 50.00 put.