Selling Options: The Dividend-Paying Limit Order

Maximizing Income: The Art of Selling Options

Updated Dec 27, 2023

If you can put in a limit order and purchase a stock, then you can put this strategy to use. It’s even safer than buying stock, in our opinion. When you put in a limit order, you have two options. You will get in at a significantly lower price if your order is filled. You can often lower your entry price from 5%-15% lower than where the actual stock is currently trading. In other words, other investors will pay 5-15% more for the same transaction, and more importantly, this is legal. In essence, you are selling options.

Unveiling the Hidden Strategy: Simple and in Plain Sight

So what is this strategy? It boils down to selling options. You sell puts. If adequately implemented, selling puts is just as safe, if not safer, than buying the actual stock, with the added benefit of getting paid to purchase a stock. If your order is not filled, you get paid for trying to. What could be better? You have your cake and your pie. Implemented correctly, this strategy can significantly boost your investment returns.

Selling puts the most misunderstood and least used option strategy. Fixed-income players should use this strategy more often than simply selling covered calls. Covered calls can be a good strategy if you utilise them adequately, which in most cases it is not, can also be an excellent strategy. In this instance, you sell calls on a stock you own. The benefit is that you get an additional stream of income. The downside is that if the stock trades above the strike price you sold the call at, your stock will be called away.

Selling Options: Essential Considerations and Tips

If you can allocate some time to mastering the basic principles of Mass psychology, it will pay off 100-fold. Furthermore, if you combine this principle with Technical analysis, the odds will be in your favour instead of the houses.

The most fundamental principle of mass psychology is understanding that emotions drive the markets; identify the feeling, and you can spot the trend. Once you know the movement, the rest of the work is straightforward. Don’t listen to the experts, as they love to spin tales regarding how fundamentals or the technical state of the market is more critical; nothing is more important than the emotional state of the crowd. In the initial stage of the bull market, you can put the basic principles of contrarian investing into play, but when the bull starts to mature, instead of bailing out, let mass psychology take over.

Recognizing the Significance of Technical Analysis with a Caveat

It plays a secondary role and not a primary role; once you know the psychological state of the market, you can put the principle of technical analysis into play. Technical analysis helps one identify when a market is trading in extraordinarily overbought and oversold conditions. Don’t confuse market topping or bottoming action with trying to determine the exact turning point.

Those attempting to determine the precise bottom or top are fools with an inordinate appetite for pain and misery. It’s like catching a falling dagger; if you succeed, your hands will be far from happy. The most important factor should be identifying the trend; once you know the direction, the rest is easy.

Embrace the Journey: You Have to Participate to Succeed

If you are not in the game, you can talk all you want, but other than barking loudly, nothing you say will increase the size of your portfolio. The only way to win is to have some skin in the game. Buy when the masses are panicking and sell when they are euphoric.

Don’t day trade; over 90% of day traders make absolutely nothing; they lose almost everything before deciding to change course. Learn from others’ mistakes and position trade instead of making very short-term investments. Identify the trend and hold your position till the trend ends.

The early bird gets the worm, the late one the bullet

If you talk too much or panic, another bird will find the worm. You must get into the game early to lock in big gains. When you get in early, you are likely to experience some pain. Warren Buffett put it nicely; if you can’t deal with as much as a 50% move against you, you should not be in the markets.

Exploring a Practical Example of Selling Options

Let’s say you’re interested in a tech company called TechCo, which trades at $100 per share. You believe TechCo is a solid company, and you wouldn’t mind owning it if the price drops.

You decide to sell a put option on TechCo with a strike price of $95 that expires in one month. The premium for this option is $3 per share.

When you sell this put option, you receive the premium upfront. Since one options contract represents 100 shares, you receive $300 (100 shares * $3 per share). This money is yours to keep, no matter what happens next.

Now, let’s consider three possible scenarios at the expiration date:

1. TechCo’s stock price stays above $95: If TechCo’s stock price is above the strike price of $95 at expiration, the put option will expire worthless. You won’t need to buy the stock, and you keep the entire premium of $300 as your profit. This is your maximum profit potential.

2. TechCo’s stock price is exactly $95: If the stock price is exactly at the strike price, the option could still be exercised, and you’d need to buy the stock at $95 per share. However, since you received a premium of $300, your effective purchase price would be $92 per share ($95 – $3 premium). You could then hold onto the stock or sell it at a profit later if the stock price goes up.

3. TechCo’s stock price drops below $95: If the stock price drops to, say, $90, the put option will be exercised, and you’ll be obligated to buy 100 shares of TechCo at $95 per share, even though it’s currently trading at $90. This would result in a paper loss of $500 ($5 per share * 100 shares). However, you still keep the $300 premium, so your net loss would be $200 ($500 loss – $300 premium).

In this scenario, you now own TechCo shares at an effective price of $92 per share, and you can wait for the stock price to go back up. If you believe in the long-term prospects of TechCo, this might not be a bad outcome.

Sage Investor Wisdom: Excellent Words of Advice

“I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful.” – Warren Buffett

“The stock market is filled with individuals who know the price of everything, but the value of nothing.” – Phillip Fisher

“In investing, what is comfortable is rarely profitable.” – Robert Arnott

“How many millionaires do you know who have become wealthy by investing in savings accounts? I rest my case.” – Robert G. Allen

“Invest in yourself. Your career is the engine of your wealth.” – Paul Clitheroe

“The individual investor should act consistently as an investor and not as a speculator.” – Ben Graham

“It’s not how much money you make, but how much money you keep, how hard it works for you, and how many generations you keep it for.” – Robert Kiyosaki

“Know what you own, and know why you own it.” – Peter Lynch