Selling deep-in-the-money puts

Question

I bought 1000 shares of xyz stock for $2.70 ($2,700) and it started dropping value soon after to $2.50. I can sell deep-in-the-money puts ($7.00 strike) currently for $4.20 per option. Meaning I would collect $4200 now. I would net $1500 dollars with expiration in two weeks. They would take my 1000 shares. I would in effect make $1500.

What am I missing here?

Ok, I think I figured it out. I am on the hook to buy their stock at the price at expiration. Not sell them my stock.

Back to the drawing board.

Answer 1

First of all, there's no way a put that's 4.50 in the money is only selling for 4.20. You must be looking at stale prices. But that said, you still have your strategy backwards.

If you sell a put, then you're obligated to buy more shares at the strike price (the other side has the option to sell). So assuming the stock stays below $7, you'd get $4,200 now, pay another $7,000 when they expire and you'll have 2,000 shares that you effectively paid $5,500 for (2,700 + 7,000 - 4,200).

Selling puts on an already long position is effectively doubling down.

If you want to reduce your exposure without selling the stock, you can either sell covered calls or buy puts. Selling covered calls gives you income now but limits your upside. Buying puts costs you money now but sets a limit on your losses.

If you instead bought the puts for 4.70 (which is more realistic), then your loss would be floored at 400 (2,700 + 4,700 - 7,000), but you'd be stuck with that loss unless the stock goes above $7. To actually make a profit overall, the stock would need to go above $7.40 (to make up for the $400 loss).