When the market goes down, it’s very difficult to make money with a strictly long-stock portfolio. If you only invest in a few stocks and you are a great stock picker (or at least lucky), then it’s easier.

However, if you have a well-diversified portfolio, with many stocks across multiple sectors, the best you can reasonably hope for is to lose less money than the market during rough periods. Then when the market gets better, hopefully your stocks will outperform on the way up.

For investors who do more than buy-and-hold, though, one common way to try to take advantage of a down market is to use options. There’s no guarantee you will end up making money in the portfolio overall, but it can help to generate some extra gains/income.

Buying a put option against a stock will make you money if that stock moves enough in your favor before the option expires. However, when you long an option, time works against you. The stock could move down but you could still end up with a loss on the trade if it doesn’t move far enough or quickly enough.

If you take the opposite position and long a put instead, you could earn extra income while giving yourself a chance to buy a stock you like at a discounted price of your choosing.

When you sell a put, you receive a premium. That’s the price the buyer pays for the right to put (sell) to you the stock at the option strike price.

How It Would Work

Let’s say you sell a July $55 put against Shell (NYSE: SHEL)—trading for about $61.50 as of this writing—for $1.50, you will receive $150 premium minus whatever commission your broker charges. If you use a discount broker, the commission should be negligible. For example, Schwab charges $0.65 per contract. Thus, let’s say you sold one put for $1.50, your net receipt would be $149.35.

If SHEL is $55 or higher at expiration, the contract will expire worthless because it would not make sense for the buyer of the option to exercise the put since he could get a better price by selling SHEL on the market. In this scenario, your gain would be the entire $149.35.

Even if the option is exercised, you could end up making a profit overall. Let’s say the option buyer puts 100 shares of SHEL to you at $55 when SHEL is trading for $54. You could still end up selling SHEL on the market at $54 and end up with a $49.35 profit including the option premium. This is because you lose $1 per share when you buy for $55 and sell for $54, but you have a $149.35 premium to offset the loss.

If you like SHEL, you can just hold onto the stock. While you ended up buying it at an above-market price, you still paid a lower price than if you had bought SHEL stock when you sold the put. Thus, try to sell a put at a strike price where you would be comfortable buying the underlying stock.

A Chance to Buy at Discount

Another way to think about this is to view the down market as an opportunity to scoop up stocks you like at a lower price while collecting a premium and adding extra income. This especially makes sense if you expect the market to rebound not far into the future. If a stock is put to you, and then it rallies, then you not only bought the stock at a lower price, but the gain that comes after option exercise belongs to you.

Note that if you are quite bearish on the market and think the market is going to keep falling for a while, you may want to consider shorting instead. A bad scenario to put selling would be if the stock is put to you at a well-below market price and then the stock keeps falling. But since you can buy to close your short put position, you do have the ability to cut your losses if you don’t want the stock to be put to you.

Another thing to keep in mind is that the broker will set aside money as a put reserve requirement. Using the SHEL example, the broker will reserve $5,500. Basically, it will make sure you will have enough money in case the option is exercised. But if the market is falling and you are comfortable with having some cash on the sidelines and waiting, then this isn’t the end of the world.

When it comes to investing, no single strategy fits everyone. Carefully consider your own financial situation, investment goals, and risk tolerance to see if put selling is right for you.

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