Generating Income Selling Short Puts

///Generating Income Selling Short Puts

Generating Income Selling Short Puts

While I was taking my hiatus from writing on this site I started to get very into selling short puts to create a tangible, income stream that can be used to supercharge my undervalued dividend growth investment strategy.  I will provide posts about what I have done (and will do), but first I think it would be useful to articulate the strategy.

What is a Put vs Call Option?

An options contract is

An options contract is a contract that allows the holder to buy or sell an underlying security at a given price, known as the strike price. The two most common types of options contracts are put and call options, which give the holder-buyer the right to sell or buy respectively, the underlying at the strike if the price of the underlying crosses the strike. Typically each options contract is written on 100 shares of the underlying

As stated, the main two types are put and call options and investopedia has a great break down of comparing the two basis of all option trades:

  • Buying a Call – You have the right to buy a stock at a predetermined price.
  • Selling a Call – You have an obligation to deliver the stock at a predetermined price to the option buyer.
  • Buying a Put – You have the right to sell a stock at a predetermined price.
  • Selling a Put – You have an obligation to buy the stock at a predetermined price if the buyer of the put option wants to sell it to you.
Since the strategy is creating “an obligation to buy the stock at a predetermined price” I would receive a premium that is paid in cash and credited to my account.

An Example of Selling a Put Option

We are going to follow a made up company with the ticker, ABC.

  • On 6/1 ABC is trading at $50/share
  • I sell a put option with a strike price of $40 with a strike date of 6/30
  • I receive a premium for creating an obligation which is credited to my account as cash

After Time Expires – What are my possible outcomes?

  • On 6/30 ABC is worth $60 – Nothing happens I keep the premium
  • On 6/30 ABC is worth $40.00 – I am forced to buy the 100 shares at $40.00 ($4,000)
  • On 6/30 ABC is worth $30.00.  I am forced to buy the 100 shares at $40.00 ($4,000) yet I am holding a position only worth $3,000

The last possible outcome is where the risk comes into play when dealing with selling naked puts.  Notwithstanding, I think my strategy directives below limit my risk to a comfortable level (even for me considering how just low my risk tolerance is).

My Selling Put Strategy to Increase Current Income and Returns with Dividend Growth Stocks

At the current time, I am not interested in trading options so I can leverage the amount of shares that I can control (remember 1 options contract = 100 shares), rather, what excites me about the strategy is the opportunity increase investment income with variables that can be controlled to lower/minimize risk.  With my mission stated, I have come up with guidelines for myself that might change over time, but I think give me a good starting point.

using options to create investment income

By | 2016-10-04T21:31:24+00:00 October 4th, 2016|Options|6 Comments

About the Author:

Evan is the owner of My Journey to Millions which was started to track his journey from a broke debt ridden law school graduate to building a positive balance. Need more Evan? Follow him on Twitter, Contact him or get new posts directly to your email

6 Comments

  1. JC October 4, 2016 at 11:01 pm - Reply

    I’ve started getting back into selling put options. It’s not a free lunch by any means but keeping a focus on your valuations and browsing the option chains you can stumble on some good opportunities. MO looks like a pretty good one right now and I just opened a new put position today. Sadly, like usual I was early so I gave up a good chunk of the premium potential, but it’s still solid either way.

    • Evan October 6, 2016 at 9:11 am - Reply

      Certainly not a free lunch, but I think the way I do it limits a lot of the risk. I am willing to forgo premium to increase the cushion between current price and strike price. My average cushion at sell to open is between 5% and 10%.

      • JC October 6, 2016 at 9:32 am - Reply

        I typically target a 10% annualized premium yield and a purchase price that I deem to be fair value or lower. That’s kind of hard to find right now though because of the markets valuation and low volatility that’s sapping the implied volatility and lowering the premiums.

        What kind of premium returns are you finding by aiming for 5-10% lower strikes?

        • Evan October 6, 2016 at 10:17 am - Reply

          Looks like my average strike price is .25 with some outliers (on both ends). I then close out at around 50% of that. So it is really about the velocity of the trades.

          Some of the names I like are HOG, WFC, SWHC (although with election I am closing these up), DAL, GME and MET

  2. easydividend October 5, 2016 at 1:34 am - Reply

    Hey,

    Congratulations on getting your blog back 🙂
    I think I will put it on my blogroll.

    I love to read an share everything about options 🙂

    best regards
    Chri

    • Evan October 6, 2016 at 9:19 am - Reply

      Thanks! I’d really appreciate that

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