How To Sell Put Options Successfully: 5 Steps To Becoming A Pro...
Yes, another blog post on how to sell put options.
Why am I so adamant about teaching you this strategy?
Because it's just that good! And if you're not involved, then you're missing out.
The way that we sell put options typically gives us a 90% chance of winning (sometimes higher!). It's a great feeling when you can win that often. "Beating the market" is fun!
Here's what one of my members said:
I have been a follower of yours since your time at Walls Street Daily and Smart Option Seller. Under your guidance, 100% of your recommendations have been profitable. - Rejean G.
Now, if you've been reading these blog posts on a regular basis, you know that selling put options not only gives you an immediate infusion of upfront cash, but it also gives you an opportunity to buy a stock of your choice at a price of your choice.
Think about that for a minute...
You control your destiny with put-option selling.
My long-term goal in the stock market is to build a diversified portfolio of quality companies - preferably Dividend Aristocrats - that can give me price appreciation along with dividend payouts.
If you're unfamiliar with Dividend Aristocrats, click here for some great information. These are the creme de la creme of dividend payers who have raised their yearly payout for at least 25 years straight.
And if you really want to go the extra mile with dividend stocks, concentrate on the Dividend Kings - these are companies that have raised their dividends for at least 50 years. Incredible!
Here's another great resource to track all the quality dividend payers. When you get to that page, click on the Excel spreadsheet that lists them all.
So, if building a long-term, diversified portfolio of high quality stocks is your thing, like it is for me, then here's how I do it:
By selling put options on quality companies for a level in which works for me. What level is that? A stock price level much lower than where the stock trades today. And if I get to buy the stock at my price, then my portfolio is on its way to great long-term gains.
Here are the 5 steps:
1. Pick a stock you'd love to buy. Make sure it's high quality.
2. Pick the price at which you'd like to buy that stock.
3. Choose the length of the trade (expiration date)
4. Sell the appropriate put option and collect the cash.
5. Sit back and wait.
Very simple.
You must know going in, that you may end up buying some of these stocks - which is a good thing! But, you must also know that you'll have to pay for these stocks, so having cash to cover the purchase will be necessary.
A side note to this strategy, is that if you do it like I do, the chances of having to follow-through and buy the stock can be a very rare occurrence.
Why?
Because I want a super good bargain, and the prices in which I want to buy the stocks have a very low chance of coming to fruition.
You see, in order to actually buy the stock at a price cheaper than its current price, the stock must fall to that level by the expiration date. If it does, then good, you get to buy the stock.
If it doesn't fall, then you don't get to buy the stock. Your consolation? You keep the upfront payment. But that's okay. You know why? Because those upfront payments can add up to tidy sums of money over time.
Here's what another one of my readers had to say on that such subject:
Thanks for another great year. I have been with you since day 1. This year I made $59,000 with 5 positions still open. - F.X.T.
How about we run through the steps on a hypothetical Dividend Aristocrat.
1. Pick a stock you'd love to buy.
Let's use Kimberly Clark (KMB) as our hypothetical trade.
Here's the current chart of KMB. It's currently trading near $135 per share and it's a Dividend Aristocrat with 47 years of rising dividends under their belt.
2. Pick the price at which you'd like to buy that stock.
Let's say you'd love to own it at a 20% discount to its current price - putting that level near $108 per share.
3. Choose the length of the trade (expiration date).
This step entails pulling up an option chain and looking at various expiration dates. If you have a length of time in mind, you can concentrate on that. The longer the expiration date, the higher the payout will be.
4. Sell the appropriate put option and collect the cash.
I've pulled up the KMB option chain for April 2020 (shown below). This is a six-month expiration date. You can choose any time frame you'd like. It's best to compare months to see how much each option pays out.
With KMB stock at $135, and wanting a 20% potential discount, I've circled the $105 put options.
This is actually a 22% discount to its current price and is paying out $.80 per contract (splitting the bid/ask).
With the 100-share multiplier, this equates to an upfront payment in your pocket of $80 for each option contract sold. Since each option contract consists of 100 shares, you can sell as many that meets your parameters.
If your goal is to potentially buy 500 shares, you can sell five put option contracts. This would deposit $400 into your trading account.
5. Sit back and wait.
That's right. Not much more to do at this point than wait to see if you get to buy the stock at expiration.
It's a waiting game.
The stock will certainly fluctuate higher and lower during this period, and the option price will change as well.
Your biggest concern is whether KMB finishes above or below $105 per share in April 2020.
If it doesn't, the option will expire worthless and you keep the $80. Unfortunately you don't get to buy any shares at $105.
If KMB finishes below $105 in April, then you will be obligated to follow-through and purchase the shares at that time. Full payment will be required. Plus, you get to keep the $80 (or however much you collected). Mission accomplished!
You will now be the owner of KMB shares and can manage the position as you would with any other stock.
A Few Requirements
As simple and as great as this strategy is, there are a few things to know going in.
These trades must be executed in an approved options-trading account.
If done using a "cash" account, your broker will require you to have the full funds on hand as if you've already purchased the stock.
This to me is not only unfair, but also an inefficient use of your cash.
Why?
Because if you haven't bought the stock yet, then why do you have to pay for it. Make sense?
You won't know until expiration (6 months away) if you'll get to buy the shares, so why would you want to keep at least $10,500 locked up? You wouldn't, so that's why I always recommend selling put options in a "margin" account.
A margin account lessens the amount of funds that are needed to be put on hold while the trade is active.
Most brokers today use a 20% "margin requirement" of the full cost of buying the shares. So instead of having $10,500 of your funds locked up, only $2,100 would be needed as collateral. Much better.
But remember, if you do in fact have to buy the shares at expiration, the full cost will be needed to be paid for.
Are There Risks?
As with any investment strategy - of course there are risks. Let's discuss.
1. The stock can keep dropping. Let's say you're lucky enough to buy KMB at $105 per share in April 2020. That would be a great discount to where it was trading six months prior. At the time, you thought that would be a great trade.
But now it's trading at $95 per share, and you're in the hole by $10. Do you want to keep holding?
Unfortunately, stocks can drop. And they can drop further than might ever be expected. So it's important to have a stop-loss in place, or a defensive strategy that might be similar to what you currently use for your other holdings.
If you ever get cold feet and decide you want out of the trade, you can always buy back the put option, which will completely close the trade.
2. Margin Call. Although your broker will only ask for an initial deposit of 20% of the stock's cost (if using a margin account), if the stock starts to drop, the margin requirement will go up. This means you will have to keep more cash on hand to hold the trade.
If you don't have the extra cash, you will receive the "margin call" to deposit more. So make sure you keep extra funds available at all times.
3. Don't sell too many contracts. Stay within your comfort zone. Don't sell more put options than the amount of shares you're willing to buy. If you only want to potentially buy 100 shares, then only sell one put option contract.
4. Don't sell put options just to receive the cash. Heed this step. Don't sell put options just because it pays upfront cash. You might be enticed to use it on dubious or high flying stocks that could blow up in your face. Don't do it! If you do, you may end up having to buy shares of a stock that you have no desire to buy.
Last Thoughts
At the beginning of this piece I wrote that we typically receive a 90% chance of winning. How does that work?
For us, we typically don't hold the trade until expiration. Our goal is to sell the put option to collect the upfront payment. And when the option moves lower in price, we buy the option back and close out the trade in that manner.
You see, option prices fluctuate higher and lower just like stocks do. And you can trade in and out of options just as you can with stocks.
So we will sell the put option at a certain price when we establish the trade, and if and when the option gets cheaper, we buy it back. This locks in a gain and the trade is complete. The obligation to potentially buy the stock no longer exists.
When we trade put options in this manner, we consider it a win when we have locked in a gain. And 90% of the time, that's what we do successfully.
Only once since 2008 have we had to buy the stock. And that just happened last month. So now we'll have the opportunity to ride the stock higher to see how much price appreciation we can gain. The upside profit potential in unlimited!
Ok, so that's it. Your 5-Step lesson to selling put options successfully.
If you'd like more information on our service that sells put options in this manner, have a look at our Smart Option Seller newsletter.
Let me know your thoughts. I'd love to hear.
Until next time...
- Lee
