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I’m focusing this week on selling puts, the most basic options strategy that acts as the cornerstone of most of my options trades. It produces the lion’s share of the income in several of my options portfolios. If you’re looking for more income, or to buy a stock at the price of your choosing, selling puts should be your strategy of choice.
I’m also hosting a live webinar training dedicated to this income technique this Wednesday at 10 a.m. ET. Click here to register for this free event.
Today I’d like to discuss the ideal setup for using a selling puts strategy.
As a refresher: Selling a put obligates you to buy shares of a stock or ETF at your chosen price if the put option is assigned.
First of all, let’s get to the most important aspect of selling puts.
You should never sell puts on something you wouldn’t want to own . . . enough said.
OK, now we can move on.
A Trade on a Top Buffett Stock
I was sifting through my charts of Warren Buffett’s top 15 holdings and discovered an interesting opportunity in United Continental Holdings (NYSE: UAL). If you look at the chart below, you’ll notice that UAL is in an oversold state on a short-term basis.
As an options trader, particularly one who prefers to sell options, this is the type of setup that I look for in a trade. The RSI is in an oversold state over several different time frames, (2) and (5), which means that there’s a good chance that a mean-reversion move or reprieve is right around the corner. As a result, I want to sell a few puts on this Buffett stock.
An Exercise in Selling Puts for Income: UAL
Again, selling a put obligates you to buy shares of a stock or ETF at your chosen short strike if the put option is assigned.
For example, let’s say you wanted to buy UAL, but not at the current price of $73.28. You prefer to pay $38.
By selling the April 65 puts you can bring in approximately $0.84, or $84 per contract. In this instance, you are selling the put with the intent of buying UAL for $65 if, at expiration in roughly 50 days, the stock is trading at or below $65.
Selling the April 65 put requires you to have $6,500 of cash in your trading account.
If not cash-secured, selling puts only require 20% of the $6,500 or $1,300, but retirement accounts and certain brokers require the puts to be cash-secured. And in this case, that would be the $6,500.
Cash-secured, the return on the trade is 1.3% in 50 days, or 9.5% in income annually.
And if the puts were not cash-secured, the return would be significantly higher. But hold on: What if we wanted more income or to lower our cost basis by more than 1.3% every 50 days?
If this seems a little complicated, I totally understand. That’s part of the reason why I’m hosting a live put-selling webinar this week. Click here to attend this event.
As you can see from the same options chain below, you have other strike prices where you can sell puts. If you choose to sell a strike closer to the current price of the stock – say, $67.50 – you could bring in even more premium (roughly $135) but the probability of success goes from 80.70% for the 65 puts to 72.38% for the 67.5 puts. So, you do have to make a few decisions as to how much risk you are willing to take based on the strike you choose.
Back to our example: I prefer to sell the April 65 puts for $0.84. The $84 is ours to keep regardless of what occurs with UAL.
If the stock closes at April expiration above $65, we keep the $84 and oftentimes repeat the process by selling more puts, maybe at the 65 strike or possibly at a different strike price. It truly depends on where the stock is trading at the time we sell the puts and how much premium we wish to bring in.
If the stock trades for less than $65 at April expiration, we are assigned the stock for $65 per contract or $6,500 (100 shares per put contract sold). Oftentimes when this occurs I will begin to sell covered calls on the stock so there is an ongoing source of income coming in.
But the fact is we are buying this Buffett stock at a discount . . . a price we are willing to pay for the stock. In this case, we can buy the stock for 12.4% less than where it is currently trading. That’s right 12.4% and that’s if it assigned to us in $50 days…and each time we sell puts we lower the cost basis even more.
Whether you want a strategy that helps with a reliable source of steady income or a strategy that will help you buy stock at far cheaper prices, selling puts is a strategy all individual investors need to know to be truly effective. Please join me on Wednesday for my free webinar on this important strategy. Click here to attend this event.