My favorite way to generate income just got even better.
Back in April, I started telling readers about a way to increase their income from investments they currently own.
At the time, I believed it was possible to more than double the amount of income you could receive from a dividend paying company using a little-understood financial transaction.
Since April, this opportunity has only become more profitable. Today it’s possible to triple your regular dividend payment on stocks you own – and I believe the only thing stopping most people from using this income secret is – again – a lack of understanding.
To help you understand how this secret works, I’m going to put it in straightforward terms. It might seem boring and ordinary when I explain it this way, but remember: this secret can help you immediately to triple the amount of income you receive from your dividend stocks.
This secret involves a form of insurance. (Yeah I know insurance is boring – please bear with me!)
You may be aware of how Warren Buffett was able to vastly outperform the stock market over the long term. Simply put, he bought insurance companies which gave him access to huge amounts of cash in hand (the float) – and he invested the bulk of it in the world’s best businesses.
But you don’t need to buy a whole insurance company to take advantage of the amount of cash generated by insurance.
Almost every stock on a major exchange has a built-in insurance market. And like “regular” insurance, it’s much more profitable to be a seller.
Just like when you insure your home, it’s also possible to buy insurance on your stock positions. And – again – just like regular insurance, it’s hugely profitable to be the seller of insurance.
I’m talking about options.
When you sell a put option, you're acting like the insurance company. You're agreeing to buy someone else's shares of a particular stock for a set price, under certain conditions, for a limited period of time.
In the case of your house, you'd exercise your policy in a disaster … say when a fire or catastrophic weather destroys your home. In the case of a put option, the holder would exercise his right to sell us his stock if the market value of his shares falls below the price we agreed to pay.
When you sell a put option, the trade works one of two ways. You either collect the entire premium without any obligation … or you end up buying shares at a discount. Considering the latter outcome, it's important to sell puts only on companies you want to own.
Let's walk through an actual options investment I told my readers about.
On April 25, 2013, I sold June $29 puts on Microsoft. At the time, shares of Microsoft were trading for $31.50.
In this example, $29 is the strike price. As long as shares of Microsoft traded above $29 by the expiration date (in this case, June 21, 2013), the option would expire worthless and we would get to keep the entire premium with no obligation to buy the shares.
When the trade was initiated, the option premium collected for selling those Microsoft puts was $0.40. Since an option contract covers 100 shares, we immediately collected $40 for every contract sold.
On June 21, 2013, the Microsoft options "expired worthless" because Microsoft shares sold for $33.50 – well above the $29 strike price. We got to keep the entire premium for a 6.9% return on margin.
That word "margin" is important. When you sell put options, your brokerage requires you to set aside 20% of your potential obligation. If I sold one option contract, I would be potentially responsible for buying 100 shares at $29 (or $2,900). In this case, I would have to deposit $580 (20% of $2,900).
Because I collected $40 in options premium and only had to deposit $580, I made roughly 7% on the investment in about 45 days. That's a 56% annualized return.
I encourage you to read and re-read today's article on selling puts. And for more information, I’ve made my recent webinar on options selling available in video form. Click here to watch it now.
Once you understand how to sell puts – and how profitable and safe this strategy is – you'll have a hard time doing anything else in the market.
Editor and Chief Options Strategist