Selling Put Options
Also known as a naked put or cash secured put. A trader would use this option if they are expecting a steady or rising price, and consider the likelihood of a decline very remote.
Payoff Diagram: Selling a put option
In this example we are using the following assumptions:
Sol Price: $100
Will is bullish on Solana and thinks that the price of SOL is going to rise steadily, and that the chance of SOL dropping is incredibly remote. He wants to invest and maximise his gains out of the potential rise, but doesn't have much capital to do so. In order to accomplish this he might sell a put option.
Will sells 100 SOL put options with a strike price of $90, expiring in three months, for $2.50. These scenarios could occur:
Scenario 1 (The price of SOL rises):
As expected the price has risen, therefore Will receives the premium paid to him. Profit on a short put option is limited to that premium received. Wills maximum gain is therefore limited at $250 (100 * $2.50)
Scenario 2 (The price of SOL stays the same):
Similar to Scenario 1, Will receives the premium, and makes a profit of $250. This is because the price has expired at or above the strike price.
Scenario 3 (The price of SOL falls):
Let's say the SOL price drops to $80. Will is assigned to buy SOL at the strike price of $90. In this scenario he makes a loss, however this would be partially offset by the premium that will received from selling the option. Therefore the most that Will can stand to lose is $10 (Strike price - current price) - $2.50 (Premium Will received) * 100 (The amount of SOL that Will bought) = $750. The other thing to note is that if Will was bullish on Solana he would just have to buy in at $90 as opposed to the $100 that SOL was trading for when he first started this trade.
Why trade it? You think the underlying asset is staying stable or rising steadily. You don't have much capital to buy the underlying or are waiting for a dip to buy the asset.
Optimal conditions? Stable / bullish asset..
Max Profit: The premium paid
Max Loss: The strike price - premium paid * amount
Breakeven at expiration: The strike price - premium