Monday, October 27, 2008

Experts are Buying Stocks - I'm Selling Put Options Instead

Warren Buffet has said he is buying stocks and Jeremy Grantham says it's time to buy stocks. However, I don't feel comfortable putting new money in the stock market yet. After all, my current diversified stock holdings are down about 50% from their highs. Also, I've already been wrong once in trying to time the bottom.

Although I still do believe the stock market will recover, I believe it may decline further before rebounding. As a result, I am selling out of the money naked puts on select stocks and ETFs. Doing so creates a win/win situation for me. If the stocks rise, I keep the premium for selling the put. If the stock falls below the put strike price, I buy the stock at a much lower price.

To execute this strategy, I do the following:

  1. Identify a stock in which I am willing and able to purchase 100 shares.


  2. Sell 1 November put contract at a strike price 20 to 50% below the current price. Selling the option obligates me to purchase 100 shares of the underlying stock at the strike price. For example, when Monsanto was in the mid 80s, I sold one November 60 put for a premium of $239. If Monsanto is below 60 on November 21, 2008, I will be buying 100 shares of the stock at 60. If Monsanto is above 60, I will make $239 profit.


  3. Wait for the November option expiration date, in this case November 21, 2008. For each option that expires, repeat for December.

In the worst case, I will need to purchase 100 shares of the stock. The good news is that the shares will be purchased at a much lower price. In the best case, the market goes up and I keep the premium from selling the options.

Since a requirement is to have sufficient funds to purchase the stock if needed, I limit the number of open put contracts to five or less at any one time.

For more on Strategies and Plans, check back every Monday for a new segment.

This is not financial advice. Please consult a professional advisor.

Copyright © 2008 Achievement Catalyst, LLC

2 comments:

Eric said...

I think you really missed the worst case scenario. The worst case is that the stock you want to own appreciates significantly, either as part of a total market rally or a secular move.

Yes, you'd earn your premium, but you'd miss out on owning a stock that you want to own.

It is easy, given the volatile market of the last 12 months to focus on loss prevention. But for long-term investors, if there is a stock that you think will outperform BUY IT.

Super Saver said...

Eric,

Thanks for the comment and great point. Missing out on an sustained upward move is a risk of this strategy.

Thus, I would not be using such a strategy in a bull market. However, at this time, I'm estimating the probability of a sustained upward move happening in the near future (3-6 months) to be very low. Of course, I could be wrong :-)