How to “Put” Your Money to Work

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2422

Abstract

r doing it. If the price stay above the strike price, then you keep the premium and were paid to wait for the price you wanted.</p><h2 id="233e">How can it go wrong?</h2><p id="df87">You can get into trouble selling puts on stocks you don’t want to own or prices you aren’t happy to pay. If either breaks down you either end up owning a bad company or a good company at a bad price. Also, its a bad idea to sell “naked” puts, where you don’t have the cash in your account to cover the cost of being assigned the shares.</p><p id="0a20">Another challenge can be if a stock price really crashes quickly after a poor earnings call. If the price falls slowly through your strike price, you can tell yourself that you would have bought at the strike price, even without the option forcing you to. When the price blasts through the strike price, you wouldn’t have had the opportunity to buy there and could have bought closer to the bottom. This can also happen on stocks you own, so for me this risk is not that big of a deal. Doing good fundamental analysis on the stock ahead of selling the put is key to maintaining your resolve. In theory, if you liked it at a $100 strike price, you should like it even more at$ 50.</p><p id="0a6b">The other major challenge can be with longer term put options. As the time duration increases, there are more chances for the fundamentals of the business to worsen such that you aren’t happy with the strike price anymore. This can be mitigated by selling shorter term options that have strike prices further away from the current price (out of the money). The trade-off will be a reduced premium.</p><h2 id="cd00">Summary:</h2><p id="0a5c">Selling cash secured puts can be a great way to generate cash flow and get paid to wait for stock prices to fall. The key is to sell puts on stocks you want to own at prices you want to own them. Keeping the strike price away from the current price minimizes the chances of being assigned the shares, but it hurts the amount of premium that you can collect.</p><p id="4e91">If you enjoyed this article, feel free to “applaud”, and you can follow me on Medium or <a href="https://carlwesterby.medium.com/subscribe">sign up for emails</a> to be notified of more stories like this.</p><h2 id="6891">Other Related Articles:</h2><div id="ee2f" class="link-block"> <a href="https://medium.datadriveninvestor.com/just-keep-buying-5d6c8b6d7092">

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What is a “put”?

A “Put” is an option that gives buyer the right to force the seller to purchase shares at a certain price (strike price). For selling this privilege, the seller receives an up front premium payment. The other important factor when considering puts, is the contracts duration. The option is obviously worth more the longer it is in effect. At the end of the contract, if the option never went below the strike price, the seller keeps the premium and is not forced to buy the shares.

Options contracts usually involve 100 shares per contract. So, if you want to sell puts with a stock trading at $100, it will require you to put $10,000 of cash on hold. This covers the purchase cost, in the event that the shares are “put” to you. American options can technically be assigned at any point over the contract period, but typically do not do so until the end of the contract. European options can only be assigned at the end of the contract period.

Why would you want to do this?

Selling put options has the benefit that you can be paid to buy stocks you like at enticing prices. If the share price never falls below the strike price, you still get to keep the option premium. Puts can also be a good way to generate cash flow on a monthly basis. This is one of the challenges with the lumpy returns of traditional appreciation investing. Divdiends can help, but they are typically quarterly and only a small percent of your return. Your expenses are monthly, so generating cash flow can be super convenient.

The key for me is that you should only sell puts on stocks you want to own at prices you would be willing to pay. This becomes win-win for you. If the stock price falls, then great. You bought a great company at a great price and were paid for doing it. If the price stay above the strike price, then you keep the premium and were paid to wait for the price you wanted.

How can it go wrong?

You can get into trouble selling puts on stocks you don’t want to own or prices you aren’t happy to pay. If either breaks down you either end up owning a bad company or a good company at a bad price. Also, its a bad idea to sell “naked” puts, where you don’t have the cash in your account to cover the cost of being assigned the shares.

Another challenge can be if a stock price really crashes quickly after a poor earnings call. If the price falls slowly through your strike price, you can tell yourself that you would have bought at the strike price, even without the option forcing you to. When the price blasts through the strike price, you wouldn’t have had the opportunity to buy there and could have bought closer to the bottom. This can also happen on stocks you own, so for me this risk is not that big of a deal. Doing good fundamental analysis on the stock ahead of selling the put is key to maintaining your resolve. In theory, if you liked it at a $100 strike price, you should like it even more at $50.

The other major challenge can be with longer term put options. As the time duration increases, there are more chances for the fundamentals of the business to worsen such that you aren’t happy with the strike price anymore. This can be mitigated by selling shorter term options that have strike prices further away from the current price (out of the money). The trade-off will be a reduced premium.

Summary:

Selling cash secured puts can be a great way to generate cash flow and get paid to wait for stock prices to fall. The key is to sell puts on stocks you want to own at prices you want to own them. Keeping the strike price away from the current price minimizes the chances of being assigned the shares, but it hurts the amount of premium that you can collect.

If you enjoyed this article, feel free to “applaud”, and you can follow me on Medium or sign up for emails to be notified of more stories like this.