While I was taking my hiatus from writing on this site I started to get very into selling short puts to create a tangible, income stream that can be used to supercharge my undervalued dividend growth investment strategy. I will provide posts about what I have done (and will do), but first I think it would be useful to articulate the strategy.
What is a Put vs Call Option?
An options contract is a contract that allows the holder to buy or sell an underlying security at a given price, known as the strike price. The two most common types of options contracts are put and call options, which give the holder-buyer the right to sell or buy respectively, the underlying at the strike if the price of the underlying crosses the strike. Typically each options contract is written on 100 shares of the underlying
As stated, the main two types are put and call options and investopedia has a great break down of comparing the two basis of all option trades:
- Buying a Call – You have the right to buy a stock at a predetermined price.
- Selling a Call – You have an obligation to deliver the stock at a predetermined price to the option buyer.
- Buying a Put – You have the right to sell a stock at a predetermined price.
- Selling a Put – You have an obligation to buy the stock at a predetermined price if the buyer of the put option wants to sell it to you.
An Example of Selling a Put Option
We are going to follow a made up company with the ticker, ABC.
- On 6/1 ABC is trading at $50/share
- I sell a put option with a strike price of $40 with a strike date of 6/30
- I receive a premium for creating an obligation which is credited to my account as cash
After Time Expires – What are my possible outcomes?
- On 6/30 ABC is worth $60 – Nothing happens I keep the premium
- On 6/30 ABC is worth $40.00 – I am forced to buy the 100 shares at $40.00 ($4,000)
- On 6/30 ABC is worth $30.00. I am forced to buy the 100 shares at $40.00 ($4,000) yet I am holding a position only worth $3,000
The last possible outcome is where the risk comes into play when dealing with selling naked puts. Notwithstanding, I think my strategy directives below limit my risk to a comfortable level (even for me considering how just low my risk tolerance is).
My Selling Put Strategy to Increase Current Income and Returns with Dividend Growth Stocks
At the current time, I am not interested in trading options so I can leverage the amount of shares that I can control (remember 1 options contract = 100 shares), rather, what excites me about the strategy is the opportunity increase investment income with variables that can be controlled to lower/minimize risk. With my mission stated, I have come up with guidelines for myself that might change over time, but I think give me a good starting point.