Value Investing

Selling puts is one of my favorite strategies. Selling a put is an options trading strategy, where you as the seller of the option are obligating yourself to buy a specific company at a specific price any time between now and a future expiration date that you pick. For that obligation, you are getting paid a premium (as explained in the Covered Call video). The premium collected varies depending on the volatility of the stock at the time, the price of the stock, and length of time until expiration. The more volatile the stock, the higher the stock price, and the longer the expiration the higher the premium you collect. If it’s a low volatile stock, a lower priced stock, and a shorter expiration, the lower the premium you collect.

Unlike the covered call strategy where we are obligating to sell a stock you already own, this strategy is obligating us to BUY a stock that we want to own. So why do I like selling puts so much? First, let’s say I have identified a great company that meets all of the criteria I have on my checklist for finding a great fundamentally sound company, but it’s not quite cheap enough to buy because we only buy when the price is on sale. Selling a put allows me to get paid to wait for it to come down to a price where I want to buy. If I want to buy XYZ at $60, but it’s currently at $70, then I collect a premium as I wait for this great company to come down to where I want to buy it.

Next, I make money in 3 directions. First, If XYZ keeps going up between now and the expiration date of my put option, I get to keep the maximum profit, which is the put premium. I get to keep this because the stock did not fall down to the price where I would be obligated to buy it, which would be $60. Second, If XYZ stays at $70 I still make the max profit which is the premium I collected. Third, If it goes down, but not far enough to force me to buy ($60), I still get to keep the premium! In each of these 3 directional moves, I get to keep the premium which is pure profit if I don’t own the stock yet, but if I already own shares, these premiums I have collected lowers my cost basis, which increase my total returns.

If XYZ does fall below $60, that is good too because now I get to buy the stock which I want to own at a discount price. This strategy is so good because when the market is overvalued, we are still able to put our money to work when finding good opportunities are hard to find. We are creating those opportunities because we could sell a long term put at a strike price that, if put, will eventually allow us to buy at a discount. However, if we are not obligated to buy, we are still making good money in a conservative fashion.

Lastly, leverage makes this a great strategy too. In a non-IRA account, you only have to have 30% of the total cost of the “If put” price available. That means if we have to buy XYZ at a strike price of $60, then we only need to have $18/share to buy this stock ($60 x .3). A $2 put premium on $60 is only 3.3%, but on $18, the rate of return is 11%. That’s also for a 3 month put, so an annual return for each would be approximately 13% vs 44%. ONLY ONLY ONLY sell a put on a stock that you want to own. I’ve seen investors get tempted to sell options on stocks that pay a high premium bc of the volatility and what could happen is that they may have to buy a stock that is junk. When we sell options, we are doing so because we want to own the stock. We identified a great company and if we get “put” the stock, we are buying it at a great price.

Please Login to Comment.