Investors seem to have an extreme aversion to selling puts.
American investors have “heard” that selling puts is inherently risky. And this belief has been reinforced by the mainstream financial media. Simply put: Most “experts” in the financial media portray this kind of strategy as too complicated for the average investor. Again, they want you to buy the next hot stock.
For whatever reason, there’s no doubting that this fear of selling puts exists. The fear is real. But the evidence for this fear is scant.
And yes, selling puts can be dangerous – but only if you use them in incredibly stupid ways.
But I can guarantee that once you learn how to use this type of investment, you will immediately begin to see the whole world of finance in a different light. Instead of “paying” people to invest your hard-earned money, you learn to get paid to invest. I know it sounds like a strange concept, but hear me out because it’s a strategy professionals have used successfully for years.
The first key to selling puts safely and profitably is knowing the real risks in owning an asset’s shares. We need to assure ourselves the assets on which we sell puts are fundamentally sound.
For instance, take silver.
It’s a commodity that we feel comfortable owning for the long haul, mostly due to the ongoing uncertainty in the global economy.
The silver ETF (NYSE: SLV) is currently trading for $19.27.
In my opinion, the price is a little inflated. I prefer to pay $18.50.
Remember when I said we want to get paid to be investors? Well, given our desire to own silver at $18.50 – we can get paid. Think about that: we can get PAID to agree to buy a silver ETF at a lower price that we prefer.
I don’t want to get into the details in this short column, but we can sell one put contract that gives us the ability to buy 100 shares of SLV at $18.50 a share – and collect an immediate $45.
And no matter what happens, we get to keep that $45. If SLV stays above $18.50 – the $45 we collected is ours.
But for the sake of understanding, we should examine the alternative – SLV closing below $18.50 by option expiration in roughly 45 days.
In that case, we’d keep the $45 and be forced to buy the silver ETF at $18.50 per share.
In this case, we’d actually own the silver ETF for $18.05 per share – that’s the $18.5 strike price minus the $0.45 premium. That 6.3% less than SLV’s current market price.
Here’s that math:
Initial income from sold put premium – $45
Purchase 100 shares of SLV at $18.50 – $1,850
Initial outlay – $1,805
The important thing to remember is that if the stock trades below $18.50 by option expiration, you become a shareholder just like everyone else . . . but at a discount.
One way to think about it is that you’d receive roughly $360 on a $1,850 investment annually. This works out to 19.5% on your money.
To me, this safe 19.5% return is superb given the current yields on bonds and other safe investments . . .
Simply, selling puts is not inherently dangerous. If used correctly, it’s no more dangerous than buying a blue-chip dividend-paying stock.
And if you’re interested in income, it’s something you owe to yourself to look into.
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