Option Strategies Details

A trader who wants to speculate on a decrease in volatility and a neutral or slightly-increasing price can sell a Put. The trader receives a credit, called a premium, to sell the Put and has the obligation to buy 100 shares at the strike price.

Suppose stock XYZ is trading at $45. You forecast a decrease in volatility and a neutral to slightly-increasing XYZ price.

You sell a $42 Put for $0.75 to express this view. Your breakeven XYZ price at expiry is $42 (strike price) - $0.75 (premium received) = $41.25, but since the time component of your trade plan may not extend all the way to expiration you should be prepared to buy to close at a variety of XYZ prices as the market value of your $42 Put changes. Because the price of XYZ can decrease to zero in theory, selling a Put without already being short shares as collateral or buying a further OTM Put to create a fixed-risk spread carries a high "risk of ruin". This means that an adverse price move, like a surprise earnings miss or scandal that decreases price greatly, can cause catastrophic losses.