Dear Student,
Like many people, I tuned into last night’s presidential debate between former President, Donald Trump, and Vice President, Kamala Harris.
And while I’m going to share my thoughts on the clear winner later, it’s important to not get too distracted from another situation unfolding that could shake up the markets in less than three weeks…
On September 30th, the government could run out of money.
Now personally, I think this will end up being the same old song and dance we always see – Republicans and Democrats will reach a deal, like always… even if it’s in the eleventh hour.
But whether they or they don’t, there’s a reliable strategy you can use to protect yourself from a potential selloff – and profit from Washington’s gridlock.
Let’s dive in…
Get Paid to Trade: Selling Puts for Income
You may have heard me say that options are like side bets – when you’re trading options, you’re not actually buying or selling shares of stock, just taking “bets” on what you think the stock is going to do in the future.
An options contract gives the holder (the buyer) the right (but not the obligation) to buy or sell 100 shares of a given stock at a set price for a short period of time. A call option gives the holder the right to buy 100 shares, while a put option gives the holder the right to sell 100 shares. And that’s what I want you to focus on today.
When you sell put options, you’re betting that the underlying stock will go up or move sideways within the next 30 days. On the other end of this trade is the buyer who’s betting that the price of that same stock will go down. And since you’re selling a put option to open the trade, you’re getting PAID right up front (this payment is called the premium).
More specifically, you’re getting cash up front – whatever the buyer is willing to pay for the put option – and you give away (or “put”) the rights on those 100 underlying shares to the buyer. And when selling put options on a stock that you want to own, even expensive ones, you can get paid big today to buy these stocks at bargain prices – much lower than where they sit today.
Here’s how it works, in three simple steps…
Opening Your Trade
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Choose a stock that you think will move sideways to higher within the next 30 days.
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Sell the put option with a strike price that’s lower than the stock’s current price and an expiration date that’s 30 days out or less. Just keep in mind that the farther out the expiration date is, the less you’ll receive for selling the put – but the higher the probability that the trade will be profitable.
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GET PAID. This is called the “premium” that you get from selling the put option.
Of course, when you open a trade, that means you’ll need to know how to close it, too. Here’s how you do that…
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Wait for the stock to either rise in price or stay exactly where it is. If the stock goes up, the put option you sold expires worthless – and you keep 100% of the premium. If the stock goes sideways, the put option expires worthless – and you keep 100% of the premium.
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If the stock does neither and moves down instead of up or sideways, you can do one of
three things:
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You can buy back the put option at its current market price.
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You can be assigned the shares of the stock at a discounted strike price (but only if you like the stock enough to do this) – OR…
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You can buy back the put option and at the same time, sell another put option with a different strike price and an expiration that’s farther out. This is called “rolling out” and is the cheapest, most effective way to leverage a losing trade – without requiring more margin. And the best part is, you save yourself from having to buy shares of the stock.
3 Potential Outcomes When Selling Put Options
Now I’ve already told you that Wall Street engages in financial propaganda when it comes to options. And selling put options is no different…
But when you do it the right way, it’s a great way to generate some fast cash each month – the kind that will allow you to book that dream vacation you’ve been wanting to go on – guilt-free, buy that car you’ve had your eye on, or even pay your kid’s college tuition early.
Of course, like any trading strategy, there are risks.
So, here’s the deal…
When you’re selling put options, keep in mind that you’ll need a small amount of cash on hand for what’s called “margin.” Think of this as collateral for the trade that’s held by your broker to make this trade.
Here’s how you calculate how much you’ll need for the minimum initial margin requirement:
(The premium of the put option + 10% of the put option’s strike price x the number of contracts you own) x 100. The minimum initial margin requirement is the premium plus 10% of the put option’s strike multiplied by the number of contracts you own – then multiplied by 100.
But just like any other type of collateral – you may not even need to use it. And here’s the thing… Remember that you get paid right up front when you sell put options. So that $500, or $1,500 – or whatever the buyer paid – it’s yours. It’s yours if you win the bet – and it’s yours if you “lose.”
Either way, you get to pocket some or all that cash you received right up front. So, in the end, it’s like getting a discount on some of the world’s most expensive and popular stocks, like Apple Inc. (AAPL), Amazon.com, Inc. (AMZN), Booking Holdings Inc. (BKNG), and Alphabet Inc. (GOOG).
Now, I want to mention that I don’t sell puts on just anything. They have to be first-class companies or commodities – like the top 350 stocks and exchange-traded funds (ETFs) my software gives me. And that’s exactly why I created the following rules to follow when using this strategy:
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Sell puts on stocks you would want to own at below-market prices
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Sell puts on stocks that have HIGHER-than-average implied volatility
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Sell puts that give you a high statistical probability – the higher, the better
This is passive income, easy income – much better than punching a clock. And tomorrow, you’ll see exactly why when we put this strategy to work (no pun intended).
Until then,
Tom Gentile
America’s Pattern Trader