Everyone knows you’re supposed to buy low and sell high. This advice is so common and so basic – and yet, almost no one talks about how to buy low – let alone how to sell high.
Today, I’d like to discuss one simple way to guarantee that you buy at exactly the low price of your own choosing – and…even better… how you can get paid to do so.
I’m not going to discuss which stock to invest in…but rather, HOW to invest in the stock of your choosing in the best possible way.
What is this magic technique?
Here’s how selling puts actually works – and how using this strategy can actually let you collect income while you wait for the price you want to pay on a given stock.
For instance, if you would like to own Facebook for $24, you could sell front-month options premium (July) for $0.65 or $65 per contract. Say you were willing to own the 300 shares of the stock at $24 for a total capital outlay of $7200.
Under normal circumstances, while you were waiting to hopefully get in at $24 your capital is sitting idly on the sidelines making next to nothing.
But if you sell puts at the strike price ($24 in this case) of your own choosing – you get paid!
I am always befuddled by the fact that retail investors choose not to sell puts, particularly in this situation.
You are willing to buy the stock at $24, so why not collect some premium and lower your cost basis even further by selling a few puts? In this case, you would sell three puts at the Jul12 24 strike because you willing to own $300 shares of the stock at $24. Remember, one options contract equals 100 shares of stock.
So again, we could sell 3 FB Jul12 24 puts for $0.65 or $65 per contact. Since we want to sell three contracts that equals $65*3 for a total of $195.
Of course, transaction costs come into play so we want to subtract the worst case scenario of $1.50 per contract or $4.50 in our case. That gives us a net credit of $190.50 or 2.6% per 40 days. Annualized that is a 24.1% return on the $7200. It would lower our cost entry from $24 to $18.20.
To reiterate – you get paid to make a promise to buy a stock you want to own, AT the price you want to pay.
I have to urge caution – and point out the obvious: you would never sell puts on a stock that you didn’t want to own at that strike price. That’s how most people get in trouble – they only pay attention to the income – forgetting that they CAN and eventually will get put to the shares.
Now… knowing that you are able to lower the cost basis of a stock that you want to own anyway, why would you choose to do things different?
I will discuss this among other options-related topics in upcoming posts on the Wyatt Investment Research website.
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