The first three trading days of 2014 were what technicians call “distribution days” where the advance/decline line shows more stocks being sold on higher volume than those bought on lower volume. It’s a very typical and normal stock trading process of how the market digests recent big gains and should be viewed as being constructive to the up trend that is very much in place for all three major averages.
As tape action goes, traders really want to see the market open down in the morning and close at or near the highs of the day, as it shows market participants are confident to carry positions overnight. For the past several trading sessions, the market has opened at or near the highs of the day only to close at or near the lows of each session.
That pattern broke Tuesday because of the flood of stock-specific upgrades in high-profile names that grabbed the attention of fund managers looking for a green light to start stock trading and commit new capital to equities. When industrials, technology and financials outperform, as they did Tuesday, the trading landscape takes on a particularly bullish tone.
While I employ a host of investing and stock trading strategies, including a portfolio of long-term dividend stocks, growth stocks and covered calls, one of my favorites is using naked puts.
It’s a simple stock trading strategy that involves selling to open (shorting) a put option, meaning you collect the premium upfront much like you do with a covered call. But in a naked put trade, when the value of the underlying stock moves up as expected, the value of the put decreases – with the hope of going to zero and expiring worthless at expiration. Then, you get to keep 100% of the premium you collected.
While in the early days of options, traders needed massive amounts of margin to accomplish a naked put, but today as long as you have permission to trade options, you can easily carry out a naked put in a cash-secured account. This simply means you have enough cash in the account to buy 100 shares of the underlying stock in the case the stock closes below the put’s strike price at expiration and are “put” the stock shares.
For this reason, I only ever write naked puts on relatively low-priced stocks, but getting put the shares isn’t a bad thing because, remember, I only write naked puts on stocks for which I am bullish. Let me give you one of my latest naked put recommendations to show you how it works.
Hilton Hotels (HLT), which was held by Blackstone Group (BX) for the past several years, went public with its IPO in December on the heels of the Twitter (TWTR) IPO. It’s just now getting up some upside momentum that should carry the stock toward $25 in short order as lodging stocks are in one of the strongest sectors. I recommend selling to open some HLT puts to take in some near-term premium.
Sell to open the HLT Jan $22.50 puts at $0.75 or more per contract. This means that if you sell (write) these puts today, you can collect $75 in your brokerage account for every put contract you write that you will get to keep if HLT closes above $22.50 at expiration next Friday, Jan. 17. With HLT trading at $22 as of Tuesday’s close, the prospects look very good.
Now, as I mentioned above, every put contract correlates to 100 shares of the underlying HLT stock. This is key when determining how many calls you want to write because in the event that HLT closes below the $22.50 strike price, you would be required to buy 100 shares of HLT stock. Each put you sell could require a cash output of $2,250.
But even if you do get put the shares, you still get to keep every cent of the option premium collected. And given that I see HLT moving to $25 in the near term, you could turn right around and sell your shares for a healthy profit. What’s not to love about that? You get paid to for getting long exposure to a stock.
Typically, companies go public in front of good news, and I would expect HLT to post strong fourth-quarter earnings which further boosts my robust view of the shares.
Bryan Perry is the editor of Cash Machine, a newsletter focused on high-yield income investing with the goal of maintaining a blended total yield of 10% across two portfolios. Bryan is also the editor of Extreme Income,which uses the power of historically cheap money to create a leveraged “baby hedge fund” strategy that paves the way to massive profits and 4x greater income.
Now is the perfect time to join Bryan Perry’s breakthrough income investing service, Cash Machine Trader, and discover how selling covered-call options can help you manufacture ‘top-up dividends’ of up to 30% per year.