Tue Feb 18 2014
Live Index (1451 articles)

A Cheaper Way to Generate Income From High-Priced Stocks

Our put selling strategy is an excellent way to generate reliable income in your investment account, while giving yourself an opportunity to buy quality stocks at a discount price.

As a quick reminder of how this strategy works, we sell a put option on an underlying stock that we would be happy to own at a lower price. By selling this put option, we obligate ourselves to buy the stock at the option’s strike price if it falls below that price before the expiration date. In other words, we are allowing the buyer of this contract to “put” the stock to us at a specified price.

As compensation for accepting this obligation, we are paid a “premium,” which is how we generate income each month selling puts.

If the underlying stock remains above the strike price through the expiration date, then our obligation “expires” and we are not required to buy the stock. We get to keep the premium we received for selling the put free and clear.

If the underlying stock drops below the strike price, then we are required to buy the stock at the strike price. Keep in mind, this strike price is often below the market price when we actually sold the put option, and we also get to keep the premium from selling the put contract. So, in actuality, we are still getting a good deal on the stock purchase when compared to what we would have been required to pay if we had simply bought the stock on the day we sold the put option.

Selling Puts on Mini Options Helps Alleviate Capital Constraints

While the put selling strategy offers a tremendous opportunity for investors to collect regular income, the approach can be challenging for investors with smaller capital levels in their account.

When selling puts, we need to set aside enough capital to actually purchase the shares at the strike price should the stock be put to us. A traditional put option contract represents 100 shares of stock. So, depending on the size of your investment account, this 100-share purchase requirement could become an issue.

This can be an especially tough if the underlying stock has a very high dollar price. For instance, if you were going to sell a put option against Apple (NASDAQ: AAPL) with a $ 475 strike price, you would need to set aside roughly $ 47,500 (less the premium collected for selling the option) to cover your potential stock purchase. If you sold a $ 900 strike put option on Google (NASDAQ: GOOG), you could wind up allocating nearly $ 90,000 for the potential trade.

The good news is that the Chicago Board Options Exchange (CBOE) is experimenting with offering “mini options,” which represent 10 shares instead of the standard 100 shares.

These mini options have been available for the S&P 500 index for a number of years now. But in 2013, the exchange opened up five new tickers that now have mini options trading: Apple, Google, Amazon.com (NASDAQ: AMZN), SPDR Gold Shares (NYSE: GLD) and SPDR S&P 500 (NYSE: SPY).
You can find all the details for this program by visiting the CBOE mini options page.

At this point, it is unclear whether the CBOE will continue to expand its range of tickers for the mini options program. But for now, the addition of AMZN, AAPL and GOOG in particular open up significantly more options (no pun intended) for individual investors.

Apart from the fact that these contracts only represent 10 shares, all other details should be exactly the same. In fact, regardless of how many individual contracts trade, prices for these mini options should trade directly in line with the “big” contracts.

This is because an arbitrage opportunity would exist if the price of a big contract was out of line with a small contract. In other words, it would be very easy for traders to “pick off” any mispricings simply by purchasing the cheaper contract and selling the more expensive one. Since both traditional and mini options contracts expire with the same obligations, the two would offset each other, provided the trader purchased the correct ratio of big to mini contracts.

Note: By using an income-generating put selling strategy, my colleague, Amber Hestla, helped her Income Trader members earn up to $ 150,000 last year. In fact, every trade she closed in 2013 — all 35 of them — was a winner. Click here if you want to get in on the action this year.

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