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CATEGORY Options

How to Collect Quick Income from Options



December 25, 2016

Millions of trading enthusiasts actively buy and sell stocks every day.

Unfortunately, they’re also missing out on an explosive way to own those same stocks at lesser costs, while retaining immediate income.

You can actually get paid to sell.

In today’s environment, CDs, savings accounts, and Treasuries yield close to nothing. The only way to collect anything from a CD is to stash you money in one for five to 10 years. But then again, we’re only talking about a gin of 2.5% at most.

It’s not exactly the ideal scenario for quick wealth building.

However, there is a strategy that helps generate consistent income each week, month and year – and you don’t have to stash your money, hoping for a respectable return.

Typically, it’ll return in the neighborhood of 2% to 10% in les than two months. And it doesn’t matter if the stock is flat, falls a bit or rises…

Better yet, even if the stock does fall, you can own the shares at a discount to the current price. While you may be skeptical such a strategy exists, put selling allows you to do just that. I’m sure you’ve heard that options are risky, too expensive, and that only the rich trade them. But let’s be honest.

Options offer you the flexibility and lower cost structures that thousands if not millions of traders use every day.

Its just part of the reason that put option selling is catching on so fast. It allows you to collect money upfront – again, just for opening the trade – and it can help generate quick income streams.

As we’re well aware, a put option entitles you to sell 100 shares of an underlying stock at the strike price on or before the set expiration date. And, as we’re well aware, there are two sides of the put trade.

There’s the buyer, who is bearish on the underlying stock. The buyer hopes the price of the underlying stock falls sharply so the option rockets as the stock plummets.

On the other side of the equation is the put seller.

A put seller is neutral to bullish. This person’s goal is for the stock to remain above a specific put strike price. If this happens, and the option expires worthless, the put seller keeps the entire premium from the put sale upfront.

In a way, the market is handing you money upfront just for taking part in the trade.

It’s similar to shorting a stock. But instead of hoping the stock drops to zero, we’re betting that the value of the put option drops to zero, allowing us to keep the deposited funds.

Let’s say for example, we decide to sell a put on the Disney (DIS) January 2017 105 put, which currently trades at $500 a contract (or $5 x 100 shares in a contract).

The $500 is the premium. This is the amount we collect immediately when we sell a put option. If the stock stays above the strike price of 105 by your expiration date, you keep the premium. It’s even better if the option becomes worthless at zero.

Once that happens, you keep the premium and the trade is over. You don’t have to worry about buying back the stock with a commission if the trade goes against you.

So what’s the strategy for finding such trades and increasing your odds of success?

To find suitable stocks for put selling can and oftentimes is time consuming.

Tip #1: Choose a Stock you Don't Owning

First – and this is essential – you only want to sell a put on a company you actually want to own, even if you have no intention of buying it.

It’s important to find higher quality stocks, such as Disney, Google, Exxon Mobil or IBM for example other than relying on smaller cap stocks that are not as reliable as a giant. Pick a stock you would really like to own.

We’re looking for solid fundamental and technical growth. We also want to make sure the stock in question isn’t too volatile running the risk of swinging below our strike price by the expiration date in question.

Tip #2: Know that Higher Premiums don't Always Guarantee a Big Win

Don’t get seduced by sky-high premiums, thinking that a higher premium means more gain. There’s a reason it’s high.

The higher the premium, the higher the expected volatility can be.

Tip #3: Trade out-of-the-money put options

Your risk of stock assignment is lower, as is the margin required to trade it. The premiums also have a tendency to fall quicker as options approach their respective expiration dates. You must remember that when you sell a put option, time decay (theta) is your best friend when you go to collect premium.

Also, know that out of the money put sellers can benefit from a stock that is flat or moves slight lower. With an in the money put option, the stock price has to increase for the put to move into out of the money territory.

Tip #4: The Shorter the Time Frame, the Better

When selling a put, use a short term dated put option, particularly those with a short life span of let’s say two months until expiration. Also, your rate of time decay (theta) will increase as the time until expiration decreases.

Tip #5: Be Careful when you Choose your Strike

Never go to far out of the money with a trade. Your premium could be nil. And if you choose one too close to the current price of the stock, you risk watching the option moving into the money. Your risk then increases and you could lose on the trade. Ideally, you want your strike price to be below support levels, such as the 50 or 200-day moving averages.

When you choose your put option strike price, which is below the price at which the underlying stock is selling, you expect for the stock to not fall that low. That way, at expiration, you get to keep your premium. You don’t have to by the stock, and you walk with your premium you were paid just for playing.

Also know this, when you sell a put you’re agreeing to buy 100 shares of a stock if it falls below the strike price you choose. Of course, should the trade go against you, you have to make sure you have enough capital on hand to buy all 100 shares.

Tip #6: Choose a Stock in a Strong Uptrend

We’re not talking about buying just any stock. Buy well-known companies likely to remain in trend and that offer reliability. The last thing you want to do is buy an unknown small-cap where you collect no premium, and hope the stock stays where it should.

A good strategy you can rely on is finding a mid- to large-cap stock that has sold off to support, at a 52-week low, or is in a sustainable uptrend holding support firmly.

Put Selling in Action

As you prepare to sell a put, make sure you are looking at the put options, and that you have selected to sell to open, instead of buy to open or sell to close

In our case, let’s choose the Disney January 105 put again.

Sell to open the DIS January 105 put with the January 16, 2016 expiration. These options last traded at $5. When you open your trade, you will instantly receive $5 per share. Remember, that an options contract carries with it 100 shares.

So, if you sold one contract of the DIS January 105 put, you would receive a premium of $500. If you sold 10 put options, you would receive $5,000. Easy.

Then, as long as the underlying stock closes above $105 by January 16, 2017 expiration, you retain the $500 or even the $5,000 you were paid to open the trade in the first place.

And there you have it. The very basics of how to sell a put, how to find a trade, and how to place your trades for immediate income… If you have any questions or comments, we’re always happy to help.


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