Put selling should be no different from any other type of investment when it comes to which companies you are willing to own.
If you’re an aggressive trader, you’ll sell puts on companies that are volatile and fast-growing. If you’re the buy-and-hold type, you’ll choose the steadier names that have long-term track records.
If you’re an income investor, you’ll look to a company that is a steady dividend payer or one that is growing its dividend.
Each type of company has a different set of rewards and challenges.
Growth companies, such as those in the tech and biotech sectors, will deliver large premiums upfront when you sell puts.
If you catch these companies early in the cycle, you could be in for a monthly treat, as you can sell puts on these companies every month and collect income.
NVIDIA (Nasdaq: NVDA) is a good example of this, as shares have almost tripled in the past year. That’s the reward; the challenge comes with volatility.
Companies like NVIDIA and Amazon (Nasdaq: AMZN) can rise or fall by double-digit percentages in a week. So focusing on just the monthly income could be a huge mistake if you are not a true believer in the shares for the long term.
You should ask yourself if you really want to own Amazon at $1,200 per share… because that is what you may be on the hook for.
The next type of company is the “steady Eddie.” Take a company like Procter & Gamble (NYSE: PG). You can expect steady, single-digit growth from this purveyor of everything consumer related. The put premium you will receive from selling puts on Procter & Gamble will reflect that safety and low risk. Hence, the premium will be much lower than that of an Amazon-type company. But on the flip side, Procter & Gamble is not going to fall (or rise) 10% after an earnings announcement.
The third type is the dividend payer. These companies tend to be the least volatile in a normal market and often sport very low premiums when it comes to put selling. Their downsides are normally limited by their ability to pay and grow their dividends.
A steady dividend payer will have slower growth, whereas dividend growers may provide both upside and income. The former will sport lower put premiums. Good examples of steady dividend payers are companies in the utility and telecom sectors.
Here I’ve laid out what your expectations on premiums should be…
Ultimately, you want to sell puts on companies that you would normally own or buy. If, for example, you’re looking to load up on tech shares “on the cheap,” you’ll pull in a ton of income, but you know full well that you risk buying a lot of stock in that sector as well.
The first and only rule on put selling – in my book, at least – is that you must be willing to own the shares that you sell puts on. There is always a chance that you will have to buy the underlying shares.
That’s my strategy, and I welcome the opportunity to buy great stocks on the cheap!
Good investing,
Karim
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Source: Wealthy Retirement