For some time, I’ve been using naked puts and covered calls generate monthly income by selling puts for my stock and options advisory newsletter, The Liberty Portfolio. Naked puts are options trades in which you sell the right for another investor to sell (“put”) a certain stock to you at a specific price (“strike price”) if the stock falls below that price on or before a specific date (“expiration date”).
Most of the time, even if that stock’s price is well below the strike price before expiration, the holder of the contract will not trigger his sell order until expiration actually arrives — just in case the stock suddenly rises in the interim.
If the stock doesn’t close below the strike price on expiration (or isn’t put to you in the meantime), you keep the money you earned for selling that contract (“premium”). If it does close below that strike price, you either must buy the stock at the strike price, or repurchase the contract, possibly for more than you paid.
The Liberty Portfolio only trades naked puts on stocks that, if put to The Liberty Portfolio, it is happy to own. The idea is that I like the stock anyway at the strike price, so why not earn some money off of it? It’s almost like a dividend. Not every stock is right for selling naked puts against. Stocks I use in The Liberty Portfolio are stocks I’ve been following for years, offering a nice balance of risk and reward.
If you sign up for The Liberty Portfolio, I’ll give you a free special report that goes into more detail about selling naked puts for income.
Here are some examples of how to generate monthly income by selling puts.
Generate Monthly Income by Selling Puts: Microsoft
Microsoft Corporation (NASDAQ:MSFT) is a good stock to start with. I’d be happy to own MSFT stock for the long haul, and it closed Wednesday at $91.85. Because MSFT will report earnings on Jan. 31, there’s more volatility since the date is coming up, and that means higher premiums.
You could sell two of the 2 March $89.50 naked puts for about $1.90 each. That gets you $380, and represents about a 2.1% return for a contract lasting 38 days. That comes to about 20% annualized. I like to aim for a 1.5% – 2.0% return per contract, but will take less on a less volatile blue-chip name.
If MSFT stock closes above $89.50 on March 2, you keep the $380 free and clear. If it closes between $87.60 and $89.50, you will still come out ahead. For example, if MSFT closes at $88.00, you could repurchase the contracts for $1.50 each. That costs $300, so you will make $80. Or you could elect to have MSFT stock put to you at $89.50, but you would have lost $1.50 per share since it closed at $88. You are still $80 ahead and you could either keep MSFT stock, or sell it then and there.
Perhaps you want to keep it for the long term. Or maybe you want to sell it and turn around and sell more naked puts. It’s up to you.
Just remember, you are selling two contracts, which means you could have 200 shares of MSFT stock put to you. So either have $17,900 available in cash, or on margin, or be able to repurchase that contract.
Generate Monthly Income by Selling Puts: BP
BP plc (NYSE:BP) is on the comeback trail, and I recommended buying BP stock here at Investorplace about a year ago when the stock was at $30. Now it’s at $44 and I think it is still a value.
You might sell three of the 23 Feb $44 naked puts for $1.30 each. You would collect $390, bringing your total to $770.
I love this sale because it earns almost 3%, and that’s very generous for naked puts. Just remember, you are selling 3 contracts, which means you could have 200 shares of BP stock put to you. So either have $13,200 available in cash, or on margin, or be able to repurchase that contract.
Generate Monthly Income by Selling Puts: Financial Sector SPDR ETF
Financial Select SPDR ETF (NYSEARCA:XLF) is another choice that can work for naked puts. Yes, you can sell options on most ETFs. Financial stocks are going to do very well, especially with the CFPB now apparently being put out to pasture.
The XLF closed at $30 on Wednesday. You can sell five of the 2 Mar $30 naked puts for $0.50 each. That will net you another $250, bringing your grand total to $1,020.
Just remember, you are selling five contracts, which means you could have 500 shares of XLF stock put to you. So either have $15,000 available in cash, or on margin, or be able to repurchase that contract.
So let’s put this all together. With these three sets of contracts, you are generating $1,020 in income against $46,100 in possible stock purchases. That means that for just 38 total days (31 in the case of the BP contracts), you will generate a 2.2% return, or 22% annualized. Most stocks only offer a 2.2% annual dividend.
If you have a margin account, about 25% of the total amount required for these purchases will be locked up and set aside, so your return is arguably 8.8%.
There are two things to remember about this strategy. During my 22 years of investing, only about 15% of my options contracts execute. Most of the time they don’t. Sometimes, however, trades do go against me. It happens. That’s why I only use stocks I am happy to own if they get put to me.
The other thing to remember is that the market could correct or crash while you hold naked put contracts. So either be ready to repurchase those contracts for a large loss in that case (or less if you are nimble), or be happy if the stock is put to you and consider buying more to average down.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance and is the Manager of The Liberty Portfolio at www.thelibertyportfolio.com. He owns shares of BP. He has 23 years’ experience in the stock market, and has written more than 2,000 articles on investing. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.