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How to Sell Put Options for Income

Let’s walk through an example of how to sell a put. After careful selection of the right stock, you decide you would like to create a monthly income stream by selling puts each month on this stock. Let’s say the stock is currently trading at $70 in the market. After reviewing the option chain, you decide to sell the 67.5 put option on this stock that expires in one month. The 67.5 strike price is out of the money and will obligate you to buy the stock at $67.50 only if the put buyer decides to exercise the option on or before the expiration date. The put buyer will only exercise the option if they make money or if the stock price is below $67.50.

As the put seller (writer), you get to collect the cash premium for the option. In this case, let’s assume it is $200 per option contract or 100 shares of stock. The investor now has a risk of $67.50 – $200 = $65.50 per option contract sold. If this amount of $6550 per contract is in the investors brokerage account, this is a cash-secured put. The potential return is $200 which the put seller will keep regardless of the trade outcome.

The investors return is calculated as $200/$6550 or 3.05%. This is a nice return on a one month put option. On an annual basis, this is a return of 36.6%! This is why I sell put options for monthly income.

Here are the details of the trade:

1 Option = 100 Shares of Stock: In this example, we sold 1 put option. In other words, we sold someone the right, but not the obligation, to sell 100 shares of stock to us for $67.50 on or before the option’s one-month expiration date (usually the 3rd Friday of the month).

$ 2 = Our Options Premium: In exchange for giving someone (the put buyer) the right to sell us 100 shares of stock at $67.50, we get paid in cold-hard cash! In options lingo, we get paid in the form of a premium. In this example, our premium is $ 2 per share. Because each options contract equals 100 shares of stock, here our premium is $ 200. This $ 200 is deposited in our account at the time of the transactions. It is ours to keep no matter what transpires before expiration (the end of the contract).

There are 2 potential trade outcomes:

  1. The stock prices stays above the 67.5 option strike price so the put option expires worthless. Put yourself in the position of the options holder (the person that buys the put option from us). The put holder purchased the right, but not the obligation, to sell 100 shares of stock at $67.50 per share. Assume this put option expires in one month. If, at the end of that one-month expiration time period, the stock is trading at a price above $67.50, why would the put holder exercise his right to sell the stock at $67.50 when he can sell at a price above $67.50? They would not exercise the put option! The investor keeps the $200 premium and has a 3.05% return in one month.
  2. The stock declines in price and is below the 67.5 option strike price. The option will be exercised and the shares of stock will be sold to us at the strike price ($ 72.50 per share). Again, put yourself in the position of the put holder for a moment. If, at the time the put option is set to expire, the stock is trading at $65, and the put holder has the right to sell shares of stock at $67.50, why wouldn’t the put holder exercise his right to sell the stock at $67.50 per share? They would. So in this scenario, the cash we previously deposited into our brokerage account ($6750) is used to purchase the underlying shares that were “put” or sold to us. Our break-even point, also referred to as our “cost basis,” is now $65.50 ($67.50 per share we paid for the stock less the $ 2 per share put premium we received from the original sale of the put option). At this point, we own 100 shares of stock and can sell them or write a covered call trade.

This is a simple example of how to sell (write) a put option for monthly income. Once we do this each month we create a stream of cash flow to help us achieve financial independence.

Last month, we were successful on all put trades and averaged 3.5% return for the month.  Imagine making $3000 or more in income each month!   Start making more income each month by subscribing to the Monthly Income Plan.

Compounding Returns with Option Selling

You have undoubtedly heard it said before – compounding returns is the eighth wonder of the world or man’s greatest invention. But to an investor it is a great wealth builder. While many income investors think of compounding dividends, this can also be accomplished by option sellers by compounding the option premium received by selling either put or call options. I think about the premium received as soon as the option is sold can be readily reinvested or compounded immediately.

Here is the formal definition from Investopedia:

Compound interest is interest calculated on the initial principal and also on the accumulated interest of previous periods of a deposit or loan. Compound interest can be thought of as “interest on interest,” and will make a deposit or loan grow at a faster rate than simple interest, which is interest calculated only on the principal amount. The rate at which compound interest accrues depends on the frequency of compounding; the higher the number of compounding periods, the greater the compound interest.

The “Rule of 72” is an easy way to calculate how long it will take to double you money based on compounding returns. For example, an investor has a dividend stock paying an annual 5% dividend. Using the rule of 72, dividing 72 by 5 indicates the investor will double his money in 14.4 years. Not bad for a dividend producing asset. Now, let’s compare this to selling options. If you make 2% per month on average, you can double you money in 36 months (72/2=36). This is only 3 years compared to 14.4 years for the 5% dividend stock! Which investment do you want to pursue?

This is the theory behind our strategy to sell puts and covered calls at get rich investments. We can generate consistent income on a monthly basis that will provide us the opportunity to compound our money and returns at a faster pace than the buy and hold dividend investing.

Learn how to compound your money and the best stocks to use in this strategy to double your money.

Get started today with the Monthly Income Report.

Proof that Option Income Writing is a Winner

With a covered call and protective put strategy, you have a win – win- win –win situation.  Here is what happens when the underlying stock changes:

  • Stock price increases –      you win by keeping the premium and either rolling up your call to a higher strike price or letting the stock get assigned;
  • Stock price is unchanged – you win by keeping the premium and possibly the stock to write more calls against it in coming expiration months;
  • Stock price slightly declines – Your amount of premium received will cover a slight decrease in the stock price so you win and keep the stock for more call writes for income;
  • Stock price declines aggressively – the protective put will gain value as stock prices decline closer or through the put strike price while you keep the premium and stock for more writes.

If you use the covered call with a protective put, you can create a great wining trade.  This is better for writing calls against a stock several months as this will offset the cost of buying a put for protection.  The protective put should be at least six months ahead of the current call expiration month when initially purchased.   This allows the investor to spread the put cost over the six month period to increase the profitability of the trade.  For example, if the protective put cost $300 to buy, the cost will average $50 per month on average.  However, if you exit the covered call position before the put expires, you can sell the put to recoup some of its cost.

In the case of a significant price decline, the put will become more profitable as it will increase in value.  The call writer can buy back the sold call
for pennies and sell a new call at a lower strike price to get more premium income.  After a few months of this, the trade should be profitable.

Option Basics – What is an Option?

An “option” is a standardized contract originated by the Options Clearing Corporation (OCC) that is exchange-listed.  A stock option is a legal right, but not obligation, to buy or sell shares of a specific stock for a fixed time and a fixed price.  The fixed price gives the option holder the right to buy or sell at a fixed price known as a strike price or exercise price.  The fixed time indicates that a option has a limited life for only a specific period of time then expires.
 
There are two types of options:
 

  • Calls – the right, but not the obligation to buy the underlying stock
  • Puts – the right but not the obligation to sell the underlying stock

How to buy & sell Options

Click to enlarge.

The underlying stock are the shares of stock that are subject to a stock option.  The underlying stock can also be an exchange-traded fund, stock index and other tradeable securities that have options.

Each listed call or put option covers 100 shares of the underlying stock.  Stock options expire on the Saturday following the 3rd Friday of each month.  This 3rd Friday is the last day the options can be traded as the market is closed on Saturday.  If the 3rd Friday is a holiday, then the last trading day will be the Thursday before.  Recently, weekly options have been open on a limited number of stocks and ETFs.  These weekly options are opened on each Thursday and expire on Friday of the following week.  This gives the weekly option a time period of 8 days from opening to close.

There are many different calls and puts trading on each security that is optionable.  Each call and put strike price of each expiration month is a separate option series.  To be part of the same series, the options must be of the same type and have the same expiration, strike price and underlying security.  

For investors, option equal income.  I have always like to identify multiple streams of income from my portfolio. For many, they like to diversify using different stocks in different industries. Others like to add additional investments such as bonds and real estate to create diversification. There is nothing wrong with investors looking to create different types of income. In fact, I believe it may be as close to the holy grail as any concept in investing. I use multiple products and strategies to create multiple streams of income. 

I am focused on generating consistent monthly income by selling options for premium using low risk strategies. You can see more investments at my website: getrichinvestments.com

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How To Trade The Calendar Spread for Income

A calendar spread, which is often referred to as a time spread, is the buying and selling of a call option or the buying and selling of a put option of the same strike price but different expiration months.  In essence, you are selling a short-dated option and buying a longer-dated option.  This means that the result is a net debit to the account.  In fact, the sale of the short-dated option reduces the price of the long-dated option, making the trade less expensive than buying the long-dated option outright.  Because the two options expire in different months, this trade can take on many different forms as expiration months pass.

There are two types of long calendar spreads: call and put.  There are inherent advantages to trading a put calendar over a call calendar, but both are readily acceptable trades.  Whether you use calls or puts depends on your sentiment of the underlying investment vehicle.  If you are bullish, you would buy a calendar call spread.  If you are bearish, you would buy a calendar put spread.

A long calendar spread is a good strategy to use when you expect prices to expire at the value of the strike price you are trading at the expiry of the front-month option.  This strategy is ideal for a trader whose short-term sentiment is neutral.  Ideally, the short-dated option will expire out of the money.  Once this happens, the trader is left with a long option position.

If the trader still has a neutral forecast, he or she can choose to sell another option against the long position, legging into another spread.  On the other hand, if the trader now feels the stock will start to move in the direction of the longer-term forecast, he or she can leave the long position in play and reap the benefits of having unlimited profit potential.

How to Find Calendar Spread Candidates

 • Check the current value of implied volatility (IV) and the history of IV over the past three to six months (free at ivolatlity.com).  Be sure the current IV is in the bottom quartile of recent IV history.

• Don’t trade a negative IV skew (if ≤ 2 points, maybe… but doubtful).

• Investigate very carefully if the positive IV skew is ≥ 4 points (suggests a big move is expected).

• Calculate the standard deviation (σ) for the candidate stock; use current IV and number of days to expiration of the front month option; look at the price range (lowest to highest) of the past week and the past month; avoid this stock if the recent price ranges are > 1 σ.

• Be sure no earnings announcements or other significant announcements are pending during the course of the proposed trade.

• Be sure you are selling > $0.40 of option premium (otherwise, commissions eat up too much of your profit).

• Calculate the breakevens (BE) using your trading software; you want a broad range between the BEs.

• Low IV stocks (12–‐20%) are conservative but require a large number of contracts; consider the effect of commissions.  Stocks with higher IVs (≥ 20%) present more price movement risk but have large premiums

Managing the Trade – Making Trade Adjustments

 • When you have traded calendar spreads for at least 6 months, you may consider adjustments. Until then, simply close the trade when the stock price hits a BE or the trade hits the stop loss you established. 

• Use the BEs or a price just beyond the BEs as your trigger.

• Close a portion of your contracts and place another calendar at or near the new price; determine the number of contracts to close and roll up or down by the number it takes to move your position delta back closer to zero.

• For example, IBM is at $172 and we put on 10 contracts of a $175 call calendar. IBM moves to $176 (our upper BE); we close 4 of our $175 calendars and open 4 $180 call calendars.  If we think IBM may move even higher, we might place the new spreads at $185.

• Don’t adjust a trade if you have < 15 days left to expiration (unless you have multiple months, e.g., you have a Jun Sep $175 call calendar; we close some or all of our Jun $175 calls, and wish to roll up to $180 but we only have 8 days to expiration; then you would sell the July $180 calls).

• Manage the new calendar spread just like the original trade (write down your management criteria).

In summary, it is important to remember that a long calendar spread is a neutral – and in some instances a directional – trading strategy that is used when a trader expects a gradual or sideways movement in the short term and has more direction bias over the life of the longer-dated option.   This trade is constructed by selling a short-dated option and buying a longer-dated option, resulting in a net debit.  This spread can be created with either calls or puts, and therefore can be a bullish or bearish strategy.  The trader wants to see the short-dated option decay at a faster rate than the longer-dated option.  The time decay is your income just like it is in the covered call trade.

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