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April 26
2011 / Strategy Article - Selling Stock Options -
Put Selling
Why Sell Puts?
Selling Puts As An Investment Strategy
Introduction
Today I
received an email from a reader asking the following:
As I'm
trying to better understand your thought process and Options
in General... tell me I understand, per my example:
Lexmark
stock today $37.43
LXK
Lexmark Puts,
Currently
the May $37 puts are selling for $1.70 Five contracts @
$1.70 = $850.
Stock
stays below $37, I get assigned 500 shares at $37 = $18,500
(true cost $18,500 - $850= $17,650) Stock goes past $37,
assignment never happens, keep $850
Downsides:
Assigned
stock and price continues to fall?
Upsides:
$850 ??
What else
am I missing? Is the goal to Sell a put with no hopes of
assignment, while gaining a smaller profit from each sale?
I am asked
this all the time, so I thought I would post it here under
the topic of Why Sell Puts? This way,
when asked by other readers, I can point them to this
article.
Many
investors cannot understand why I would set up put
selling as an major options investing strategy. In fact most
investors do not consider stock option selling as "investing".
Every week I get emails from readers "complaining" that
put selling is not investing. I also always hear that
options are "too risky". However understood
properly options selling in options investing at its finest.
It is very worthwhile for investors to learn what is option
trading and how to implement it.
However I
can understand the comments of these investors. Most have been "raised" on the
understanding that investing is buy a stock, mutual fund or ETF, it rises and then it is sold at some time for a profit.
For most investors this seems like "true investing". But as
we all know, most investors never know when to sell and many
buy when the stock is high not low, so the reverse happens.
As well
many investors point out to me that when I sell puts
I have removed myself from making more income should the
stock rise in value while I am holding naked puts at a
specific strike for a specific amount. Just as in the above
email, where the sender says
Upsides: $850.00??
But if I
feel the stock is in an uptrend I can keep closing my
sold puts and sell more puts higher up following
the rise in the stock's value so my upside is not actually
limited. This is indeed the best of both worlds, stock and
option.
Their complaints are all
valid points, but often they are made by investors who have
not taken time to study put selling or options in
general as an investing strategy.
Done as an
options investing strategy, its generates consistent monthly profits
that allows for constant compounding of my capital.
Consider for a
moment earning just 1% a month on a portfolio of
$200,000.00. The first month the portfolio earns 2000.00.
This means that the next month I now am investing
202,000.00. The second month then my return of 1% is
2020.00.
Here is the first
year:
Month 1
Earn 2000.00 - Available to invest for next month -
202,000.00
Month 2
Earn 2020.00 - Available to invest for next month -
204,020.00
Month 3
Earn 2040.00 - Available to invest for next month -
206,060.00
Month 4
Earn 2060.00 - Available to invest for next month -
208,120.00
Month 5
Earn 2081.00 - Available to invest for next month -
210,201.00
Month 6
Earn 2102.00 - Available to invest for next month -
212,303.00
Month 7
Earn 2123.00 - Available to invest for next month -
214,426.00
Month 8
Earn 2144.00 - Available to invest for next month -
216,570.00
Month 9
Earn 2165.00 - Available to invest for next month -
218,735.00
Month 10 Earn
2187.00 - Available to invest for next month - 220,922.00
Month 11 Earn
2209.00 - Available to invest for next month - 223,131.00
Month 12 Earn
2231.00 - Available to invest for next month - 225,362.00
TOTAL EARNINGS -
25,362.00 = 12.68%
Then think about
10, 20 and 30 years of this type of growth.
This is a pretty
simplistic example but it describes the process of
compounding my earnings through options investing.
The picture I
have chosen for this article is of an investor growing his
"investments" from a "small plant" because to me, that's
what selling naked puts is all about. I plant the seed
through selling puts, and each month my "plant"
keeps growing "taller".
I realize that an
investor who buys stocks and sells them when they rise, can
easily match my returns and in many cases do better. I'm not
arguing that put selling is a must strategy for
everyone or that it is a superior investing strategy. What I
am saying is that when implemented properly, with clear
goals and objectives stock option selling can create steady income in
every market condition, offers some protection from a
downturn, can get me into a stock at a lower level and most
important, I can earn enough over a period of time that I am
using other people's capital to pay for my stock when
assigned.
For me I have
been doing naked puts for over 3 decades. I started at a
time when options were available only on a handful of stocks
and ETFs were not "invented" yet.
There are
literally hundreds of investing strategies and styles.
Whether or not one is more superior to another I wouldn't
know and most of the time it depends on the individual
investor and their level of comfort when putting their
capital at risk through investing. What I do know is that
after years of paper trading and working with small
positions, I developed a variety of strategies that for me
have created consistent small monthly profits which over
time has grown my portfolio considerably. It has been good
in bull and bear markets.
So perhaps to
understand "Why Sell Puts" let me take apart the email
question and answer it in parts.
Read Part 2
