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:
- Identify a stock in which I am willing and able to purchase 100 shares.
- 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.
- 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.
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This is not financial advice. Please consult a professional advisor.
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