Sunday Edition: Put Selling as a Conservative Investing Strategy

We recently decided to add a Sunday Edition of Investiv Daily to mix it up a bit. We hope you are enjoying the daily content provided by Sven Carlin, one of the sharpest analysts and investors we know.

In the Sunday Edition we plan to publish content which is more educational in nature and can help you become a much better investor.

These first few issues will focus on what we believe is one of the safest and most profitable investing strategies that exists.

Over the last two years this strategy has averaged nearly 30% per year, compared to only 3.3% for the S&P 500.  

The content we will be sharing over the next few weeks is written by Thomas Moore, Chief Editor of Rebel Income, and has been pulled directly from his weekly posts to his paid subscribers.

Thomas’ investment advice doesn’t come cheap (a 1 year subscription is $1,164). At the end of his article we’ve arranged a special offer for you to follow his exact income trades for the next 30 days.

Whatever you do, make sure you read these new Sunday posts. These next few will give you insight and understanding about the most important income strategy for retirees and soon-to-be retirees and can’t be found anywhere else.

Here’s Thomas:

Put Selling as a Conservative Investing Strategy

If you’re new to income-based options trading, you’re probably still trying to get used to placing trades on a “Sell to Open” basis. The thing about covered calls is that they are very simple – buy the stock, then sell an out-of-the-money call on the same stock. Put selling, admittedly, is a different animal. If you haven’t spent a lot of time with put selling, you might struggle a little bit to understand the reasons and risks associated with put selling.

Because put selling requires a higher level of authorization and (outside of an IRA account) setting up a margin account with your broker if you want to sell naked puts, it is almost automatically assumed that put selling is a risky strategy. You may have even heard your broker tell you that put selling was a “very aggressive” investing strategy. That is a true statement – but only if you are selling puts naked and not following my approach.

The Truth According to Your Broker

Here’s why brokers and investment advisors want everybody to believe put selling is risky. Suppose you sell a put on a $50 stock with a $50 strike price. By the time expiration day comes, the stock has dropped all the way to $35. You will be assigned the stock at this point, and you will buy the stock at $50 per share, because the strike price is the price you are contractually obligated to complete the trade at. Right out of the gate, you’re down $15 per share or 30%, not counting the premium you brought in when you opened the trade. This is where brokers and investment advisors stop for a dramatic pause to let you react emotionally to the idea of such a big drop; and then they follow up with something like, “nobody wants to have to take that kind of loss.”

I won’t pretend that the very dramatic picture I’ve just painted doesn’t happen, because it absolutely does. I am sitting on stock positions today that fit this description almost to a T. The truth, fortunately for anybody who really pays attention and understands the opportunity a put sale actually gives you, goes much further than otherwise well-meaning but ignorant advisors and brokers tell you about. The picture is much bigger than the limited view I’ve given to this point, and the fact is a lot of investors are either too ignorant or are unwilling to exercise the patience and diligence a successful implementation of put selling requires.

Let’s expand the view of this trade a little more. Suppose now that before you placed the trade, you noticed that the company had built a solid reservoir of cash reflected by its Free Cash Flow, that earnings had been increasing on a consistent basis along with revenues, and that what debt the business carried was clearly contained by a low Debt to Equity ratio. Additionally, the stock paid an annual dividend of 2%. When you analyzed the stock’s price chart, let’s further suppose you noticed that although the stock was trading at or near historical lows, it had established a solid pattern of support along pivot low points. Because the stock is at historical lows, you also notice that it’s Price to Earnings ratio is quite a bit lower than the average for its industry. Given the fundamental strength of the stock’s business, the likelihood that the stock’s poor price performance is being primarily driven by simple buying and selling dynamics in the market in general rather than on any real problems with the stock itself is pretty high.

Since every stock experiences cycles between highs and lows, the truth is that a fundamentally strong company with a stock price at historical lows should be viewed as a solid opportunity in the long-term. This additional information I’ve just given you is the kind of picture some of the most successful investors in the history of the market, like Warren Buffet, Benjamin Graham and a host of others, have looked for as they built their own fortunes. It’s an approach that you might recognize by its popular name – value investing.

Understanding the Real Truth of Put Selling

I refer to put selling as a conservative way to generate income because when I combine the techniques of put selling with the discipline and patience of value investing, I get a way to generate income while at the same time managing risk in a practical, long-term way. Since the stock is already at historical lows, the odds of seeing the stock go up are higher than for a stock that is already running at historical highs from a long-term upward trend. That means that when I sell a put, there is a good chance the stock will stay above the strike price of my put option at expiration, so the option expires worthless and I can move on to the next trade. It might be another put sell on the same stock, or I might find a new one to work with. An expired put sale is a great result in my book. I try to maximize that possibility even more by selling put options that are at least two, three or sometimes even four strike prices out-of-the-money.

Another truth is that just because a stock is at historical lows and may be consolidating a pivot support, it isn’t a given the stock will go up. There is, frankly, an equal chance the stock will drop below the strike price I’ve sold. That is why I will sometimes state in these articles that the strike price I choose for a put sale is a price I’m willing to buy the stock at. I sell the put with the clear understanding I might be forced to buy the stock at that strike price, and if I’m not okay with that idea, I won’t sell the put at all.

Since I’m screening the stocks I use for these trades based on their fundamental strength and looking for a clear value-based advantage, the put sale gives me a gateway to the second part of my income generation system, which is selling covered calls. If I like the stock and don’t mind owning it at the strike price I sold, why not use my ownership to generate some more income from the stock while I can? Selling out-of-the-money call options let’s me keep generating income while simultaneously letting me lower my cost basis and set up a net profitable scenario if the stock closes above my call’s strike price at expiration.

Seeing the stock drop even several dollars below my assignment price doesn’t scare me away from the trade, primarily because of the fundamental strength my analysis is designed to screen for. In the case of these extreme trades, it usually just means that I need to exercise a little more patience and be very cautious about selling calls against the stock. If the stock appears to be consolidating or building some bullish momentum, I’ll usually just hold onto the stock until it starts to get back into the general price area I was assigned at. If I see a clear downward trend, I’ll look for opportunities to sell out-of-the-money call options that are usually further out-of-the-money than normal to sell to keep lowering my cost basis on and which are within just a couple of weeks or less to expiration. A few stocks in the past year I’ve done this with include Pandora Media (P), Abercrombie & Fitch (ANF), U.S. Silica Holdings (SLCA) and Schlumberger Ltd. (SLB).

To be clear, this last part of my system—dealing with stocks that have dropped significantly below my put option’s strike price—is what requires the most discipline and patience. It requires diligence in paying attention to the company’s fundamental news and earnings information and being willing to act if I see a serious degradation in the strength I identified at the beginning of the trade. Fortunately, it just isn’t that common to see a well-run and effectively managed company suddenly stop being well-run and managed, which is why in the last year I’ve only had to unwind one position out of the several dozen I’ve held. The discipline and patience I’m talking about, however, isn’t something that everybody can exercise. I’ve heard from traders who have subscribed to my Rebel Income blog but who didn’t want to deal with put selling on these kinds of terms. While I find that unfortunate, I recognize and readily admit that if you’re just looking for a quick buck or a way to get in and out in a hurry, my system isn’t for you.

If you’re new to put selling, I hope this explanation gives you some encouragement to stick with it; it’s what I’ve seen the best success at in more than two decades of experience in the stock market.

As you can see, put selling is actually safer than just buying stocks outright. Especially when combined with a deep value approach to stock selection, technically oversold stocks, and strong support levels. 

Over the last two years Thomas has closed exactly 101 trades, of which 98 have been winners with only 3 small losers. Quite frankly his track record is unheard of in the financial publishing business.  

To follow Thomas’ put selling income picks for the next 30 days for only $9, with no obligation to continue, and get two incredible bonus items free, click here


Shane Rawlings
Co-founder, Investiv