Selling put options can be a great way to help increase the value of your portfolio without taking on too much risk. At its core, a put sale allows investors to get paid to potentially buy shares of a company they like at a price they like.
But what if you have no interest in being put shares? What if you wish to just collect income?
Fortunately, there’s good news. With a few simple strategies, any investor can significantly reduce the risk of being put shares.
That will allow you to take advantage of the power of selling put options to generate portfolio income without having to buy large blocks of stock.
Remember, selling any option is really about selling the time premium. The closer to expiration, the less time premium there is. Typically, time premium starts to decline at the fastest rate (known as “theta decay”) about 90 days out.
So for a put seller, the first strategy is to sell an option long enough out to get a reasonable time premium. Anything longer than a few months may take too long to play out.
Shorter trades offer little time premium relative to the risk. The less time you’re in the market, the less chance something can go wrong and you end up owning a stock.
There’s a simple way to avoid being assigned shares: Get out of the trade and book profits well before expiration.
If you sell a put option three months before it expires, you may want to close out with a month left. If the underlying shares go up, or at least don’t go down, the option will lose most of its value by then.
An option sold for $5 that drops to $1 has already made 80 percent of the expected return. There may be better alternative trades at that point rather than keeping money in the trade trying to squeeze out the last dollar.
Before trading costs were dropped to zero last year, a few online brokerage accounts provided free trades on options with a miniscule amount remaining.
The other advantage of this strategy? You’re not sitting around waiting for an option to expire only to have the underlying stock dive.
All too many put sellers have had this happen, so leaving some money on the table isn’t the worst idea.
Treat it like a business
Besides those technical factors, there’s an important psychological one as well. It’s essential to treat put selling like a business. Investors looking to acquire shares can select companies that they wouldn’t mind owning for a significant period of time.
A pure put seller, however, needs to look objectively at each trade and know when to take the risk off the table. Those looking to just profit from just the put sale trade need to find stocks with high premiums, which usually occurs from a recent selloff.
Also, shares need to rebound, or at least stop falling, for the best results.
Now, as with any investment strategy or business, it’s best not to get greedy in the short-term. Used safely, this strategy will create 1% to 2% gains each month with a low risk of being assigned shares.
Reaching for a higher return greatly increases the chances of owning shares.
Yes, it may not sound like much, but it works out to 12% to 24% per year. That’s far better than the stock market’s average annual performance of 7% after inflation.