The best-kept secret for generating income from your portfolio is selling options.
Now, before you run away screaming because of the word “options,” you should know that selling options is a conservative strategy.[ad#Google Adsense 336×280-IA]And it can create a meaningful income stream for you, amounting to thousands of dollars per year.
Let me explain.
Rent Stocks Instead of Owning Them
I’m a big believer in hanging on to quality dividend payers for many years.
But you can also buy a quality dividend payer with the plan to own the stock for only a few months.
During that time, you’ll collect the dividend and also sell a call option.
The buyer of the call option is betting that the stock price will go higher. As a result, the buyer has the right, but not the obligation, to buy the stock at a specific price from the seller.
For example, Microsoft (Nasdaq: MSFT) closed Friday at $52.64. You can sell the January $55 call for $0.88. That means the buyer of the call will pay you $0.88 per share, or $88 per contract because option contracts are sold in lots of 100 shares. You keep the $88 no matter what happens.
If by the third Friday in January (options typically expire on the third Friday of the month) Microsoft is still below $55, the option expires worthless and you still own your stock. If at any time before the third Friday in January Microsoft trades above $55, the buyer has the right to demand the stock from you at $55. It doesn’t matter if the stock is trading at $55.05 or $75. You will sell it at $55.
If you sell it at $55, you still made $2.36 (55 – 52.64 = 2.36), plus the $0.88, plus the $0.36 dividend, for a total of $3.60, or a return of 6.8%. Compare that to the 2.7% yield you’d receive for owning Microsoft for an entire year. In our example, you more than doubled the annual income in just two months.
And you can make this type of trade over and over again, collecting a year’s worth of income every two months or so.
The risk is the same as owning any stock, so you want to sell covered calls on stocks that are stable. You don’t want to do this on speculative or volatile names.
Another Type of Trade
In the example above, I showed you that you are taking the other side of the bet of the person who thinks the stock is going to go up. Now we’re going to do the same thing with someone who thinks the stock is going to go down.
There’s a difference though; when we sold calls we had the stock in our portfolio. This time we’re selling puts, but don’t own any stock. If the trade goes against us, we will buy the stock from the put buyer.
To use Microsoft as an example again, if someone owns Microsoft and is concerned that the stock is going to go down, they could buy a January $50 put for $1 per share, or $100 per contract. Since we are selling the puts, that means we put $100 in our account immediately.
Our obligation is to buy Microsoft at $50 if the buyer demands it. If Microsoft never falls to $50, we don’t buy the stock and we keep the $100. If the stock drops below $50, we may have to buy it. It doesn’t matter if Microsoft is trading at $49.95 or $40. We still have to buy it at $50. That’s the risk.
So the way to sell puts is to sell puts only on those stocks that you’d be happy to own and only at the prices you’d want to own them.
Let’s say you don’t want to buy Microsoft at $50, but at $45 you think it’s a good value. Instead of selling the $50 put, you’d sell the $45 one. If Microsoft sinks, you get to own the stock you want at the lower price that you wanted. Plus, you still keep the option premium.
Like a covered call, you can do this type of trade over and over again, generating income on a weekly, monthly or quarterly basis.
Since you need to be approved by a broker to make these types of trades, contact your broker if you’re interested in selling options to add some income to your portfolio.
And remember, you don’t have to sell just one contract in either of these types of trades. Depending on the size of your account, you may be able to sell two, five or 10 contracts. Or you may choose to sell an option on Microsoft this week and Pfizer (PFE) next week and McDonald’s (MCD) two weeks later. So the amount you collect on an annual basis can easily amount to thousands or tens of thousands of dollars.
Selling options is a great way to generate extra income – and it’s one most investors don’t know about. It’s like finding a pile of cash. You just need to know where to look.
Hoping your longs go up and your shorts go down,
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Source: Wealthy Retirement