Put Option Selling: How To Buy Stocks At A Discount & Get Paid For It
by Martin Denholm, Managing Editor, Smart Profits Report
and Lee Lowell, Futures Options & Commodities Specialist, Smart Profits Report
Wednesday, March 25, 2009
We’ve received some questions recently, asking for more details on one of the most effective and profitable investment strategies that you can use in a market like this.
It’s called put option selling.
Karim touched on the topic in yesterday’s column, but I want to give you a full rundown on how this simple strategy works. And to do so, I’ve enlisted the help of the master… my colleague, Lee Lowell.
Lee has used put option selling to profitable effect in our Xcelerated Profits Report newsletter and, even more impressively, in his Instant Money Trader (IMT) service, which focuses exclusively on it.
In fact, since Lee launched IMT last autumn, he hasn’t had a single losing recommendation. Let’s see how it’s done…
Put Option Selling - Busting The Myths
If you’ve got this far, you’re on the right track. Many investors hear the words “put” and “selling” in the same sentence and head for the exit. Too complex. Too confusing. And downright scary. Or so the myth goes.
Let’s bust that myth right away. Put option selling isn’t difficult to execute. In fact, it’s actually easier than most investment methods.
When you place a put-sell trade:
- You don’t have to buy a stock.
- You don’t have to sell a stock.
- It’s got nothing to do with bonds or currencies.
- And there are no complex parameters to the trade.
Here’s the deal: You’re either going to make money, or you’ll end up investing in a company at a ridiculously low, discounted price.
What you try to do is buy stocks for the price you want. And just for trying, you get paid for it.
It works in rising markets… falling markets… flat markets… any market. It’s a regular stock-buying strategy with a profitable twist upfront. Here’s how it works…
How To Execute A Put-Sell Trade
Ever wanted to buy a stock, but passed because the price is too high for your liking?
Most ordinary investors would simply sit on the sidelines and wait for the price to fall to a better level. But smarter investors know they can still get in the game by selling a put option on it instead. All you need to do is…
- Pick your chosen stock.
- Decide on a lower price, where you’d feel comfortable buying the shares.
- Check the put option prices for that level. For example, if the stock is trading at $20 and you want to buy it for $15, you’d select the $15 strike price and an expiration month.
- You then sell those put options. Since each stock option contract is equivalent to 100 shares, you’d sell five put option contracts if you want to buy 500 shares.
When you enter a trade like this, you’re obligated to buy those shares at your stated strike price by expiration. Keep that in mind when selling the contracts, so you don’t over-extend yourself. For example, if you sell one $15 put option contract, you’ll need to have $1,500 on hand by expiration day to cover the cost of the shares ($15 x 100 = $1,500).
Note: You don’t need to have all that money on hand while the trade is open. Your broker will only ask you to keep a fraction of that amount available - known as a “margin requirement.” Consider the trade as a “buy now; pay later” type of deal. You’re putting off paying for the stock until a certain scenario occurs (see below).
In exchange, the option buyer will pay you for each contract you sell while you wait. This is known as a “premium” and is deposited into your trading account (the farther out the expiration date, the more money you’ll receive when selling the option). Meanwhile, ordinary investors are just waiting for the price to drop without collecting any money.
Okay, then what happens?
What To Expect on Options Expiration Day
On options expiration day, you’ll have two scenarios:
If Your Stock Trades Below $15:
- For every put option contract you sold, you’ll be obligated to buy 100 shares at $15 each. This is what you wanted - a 25% discount from its $20 price when you executed the trade.
- Plus, you get to keep the money that the option buyer paid you.
- The shares will appear in your account on the Monday after option expiration. It will now be a regular long position and you must manage it as you would do for any other stock. That’s why it’s important you pick a price at which you’re comfortable holding the shares.
If Your Stock Trades Above $15:
- The put options will expire worthless.
- You won’t get to buy the shares at your chosen price, but you will get to keep the money for selling the contracts, just for trying.
So regardless of what happens, you keep the money from selling the put options upfront. Now let’s bust another myth…
Selling Put Options - No Riskier Than Stocks
Selling put options is no riskier than buying shares outright. When you buy shares, the risk is that you lose your entire investment. When you sell a put option, you’re obligating yourself to buy shares, too… but at a much lower level than the current share price. And if you do end up buying the shares, your risk will be the same a regular shareholder.
The difference is that nobody pays you cash to buy stocks outright - but they do when you sell put options. Selling puts is just another way to invest using the options market.
While some brokers see selling put options as riskier than stocks (and require that you keep more capital reserves on hand), your risk only kicks in if you’re obligated to buy the shares. And even then, you’d simply be long on the stock, with the same risks as with any stock.
Of course, the worst-case scenario is that the stock falls to zero. But brokers never seem too restrictive when investors buy shares outright, rather than options.
An Important Note On Selling Put Options
Many folks don’t know about strategies like put-selling. But we wanted to bring this pro strategy to your attention as an example of what’s working in the market right now. We all have to adjust and adapt to the new realities facing us.
That said, selling puts isn’t necessarily for everyone. You’ll need to check with your broker to make sure you’re approved to trade options - and specifically, selling put options.
But if you want to take advantage of today’s financial mess to implement one of the best investment strategies for a market like this, then check out Lee’s Instant Money Trader, which is dedicated exclusively to selling put options.
And rest assured, Lee is not a gambler. In fact, he’s one of the most conservative, risk-averse investors I know. He only looks at trades that have a high probability of success - as his track record proves. Give it a risk-free, no obligation look and see what you think.
Best regards,
Martin Denholm - Managing Editor, Smart Profits Report
Lee Lowell - Editor, Instant Money Trader
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