|Editor’s Note: This article was originally published back in January. But Chief Options Analyst Lee Lowell has informed us that this strategy is more useful in today’s market climate than ever before.|
I recently outlined an amazing trading strategy that allows you to get incredible bargains on stocks you want to buy.
And you get paid upfront cash in the process.
Since it’s almost like stealing from the market (legally), Wall Street Daily readers have expressed an insane level of interest in learning more about this technique. So I thought I’d break it down in a bit more detail.
After you see this, you’ll realize just how easy this powerful strategy can be.
If you didn’t catch my recent article on put-selling, be sure to check it out first.
Put-Selling Step #1: Carefully Select Your Stock.
The first thing you need to do is decide which stock you’re going to sell puts on – and at what level.
How do you do that? Well, the first thing to realize is that we need to be reasonable. Just because this strategy allows you to get an excellent bargain on your favorite stocks, doesn’t mean you’re going to be able to buy a $100 stock for $5 in short order.
It would be more reasonable to go, say, $10, $20, or $30 lower.
Let’s use IBM (IBM) as an example.
IBM hasn’t dipped to $120 since mid-2010. And it would represent a discount of roughly $40 to its current price. Not a bad place to own shares!
Of course, I employ several detailed metrics before I come to a final decision, but that’s a solid first step.
Put-Selling Step #2: Find the Corresponding Put-Sell.
This is a very important step, as you’ll figure out how much money you can be paid for varying time frames.
All options have an expiration date. And the longer the time frame, the more money you’ll get paid. But that doesn’t mean you should just select the longest-dated option.
When selling option contracts, it can actually be smarter to pick shorter expiration periods, because that gives the stock less time to fall to the desired level.
That may sound counterintuitive, since one goal of this strategy is to ultimately buy the stock (which would only happen if shares dropped to the strike price by expiration).
But if you employ this strategy over time, you’ll realize that collecting those upfront payments from the sale – without having to buy the stock – can be extremely lucrative.
If you repeat that process over and over again, you can collect mountains of cash.
Personally, I thrive on the constant collecting of premiums, and I approach this strategy from that point of view. Gaining control of the shares is secondary for me.
To see how much money you can be paid for these options, you need to pull up an options chain from your trading software or through your broker. Below is a sample chain of IBM options that expire in July 2015, approximately seven months from now.
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This option chain shows put option prices for the $85 strike price all the way up to the $160 strike price as of January 2, 2015. “Strike price” is the word to describe the option contract corresponding to the levels of IBM that you could possibly end up buying. Let’s look at the $120 strike price and see how much money we could get paid.
Once you find the $120 strike price (highlighted above), check out the “Bid” column. It says 1.02. That means if you sell this put option, the put option buyer will pay you $1.02 per each option contract you sell.
Now, since option contracts are the equivalent to 100 shares of stock, you need to multiply the $1.02 by 100 to get the final dollar amount you’ll receive. So in this case, you’ll receive $102 for every contract you sell.
If you sell five contracts, you’ll get $510. If you sell 10 contracts, you’ll receive an instant $1,020!
This is money paid to you instantly, no questions asked. You can do whatever you want with it and never have to pay it back. If shares happen to fall to $120 by July 2015, you would be obligated to buy the shares.
You can pick any level and expiration period you like.
Put-Selling Step #3: Wait.
Your job at this point is to just sit back and wait until July. Only two outcomes can occur at July expiration:
- IBM stock stays above $120 per share. If this occurs, you keep your money, and the option will expire worthless – disappearing from your account. This is a good thing. If you want, you can now repeat the process again using a new IBM put option.
- IBM falls below $120 per share. If this occurs, you will be “put” the shares at expiration. This means you’ll have to make good on your obligation and pay for the shares in full at that time. If you sold one option contract, you’d have to pay for 100 shares of IBM at $120 each. That would require an outlay of $12,000 from your account. If you knew this going in, and were happy to buy IBM at $120 per share, then mission accomplished. You’ll now be the proud owner of IBM. Just remember, although you have to pay for the shares, you still get to keep the money you received upfront.
The ultimate goal of put-selling is to either keep collecting instant cash throughout the year, or obtain shares of your favorite stocks at very attractive prices.
It’s a very unique and safe trading method – one that can complement or replace your current system of generating cash and buying stock.
Just remember, only sell put options on stocks that you have a genuine interest in owning, since there’s a chance you may have to buy shares. Sticking to solid companies with strong long-term potential is a good rule of thumb.
Before you sell put options, you need to have a funded options trading account that’s approved for margin capabilities and option selling. This typically will require approval from your broker and possibly an extra form to fill out. Make sure these are in place before you start selling.
Chief Options Analyst, Wall Street Daily