Easy Income Fundamentals: Safe Options

I’m a big fan of value investing for the long-term.

But as the U.S. stock markets continue trading in a decade-long sideways pattern, those needing current income may be getting frustrated and restless.  You have diligently saved for retirement but you’re not currently getting the monthly returns you need to pay the bills.  While you’d like bigger dividends, you’re not willing to take on the increased risk of owning less-reliable, more-volatile stocks or junk bonds.

Enter Safe Options.

Selling naked puts (to open) or covered calls (to open) sounds complicated, but it isn’t.  And, importantly, it’s really worth it to learn how to do it!

Let me show you today how I sell naked puts:

1.  Think of a great stock (company) you’d like to own, ideally one with a healthy dividend and a strong balance sheet.

2.  What is the current stock price?

3.  Would you like to buy it at a cheaper price?  (Yes!!)  *Shockingly, the market is willing to pay you significant money today if you promise to buy shares of your favorite company later at a lower price.  If the stock price is higher on that later date than the Strike price, then you don’t “get put” (or buy) the stock, you just get to keep the money!  If the share price on that day is lower than the agreed upon Strike price, then you get to buy the shares for the Strike price, and you keep the original money they paid you for the promise!

4.  Go to your brokerage website and click on “Options trading,” or something similar.  Look for the heading “Puts”, “Calls and Puts,” or something similar.  Type in your stock ticker.  For a time frame, use the next 2-3 months.

5.  Refer to the current price of your stock.  Look at how much the market is willing to pay you in 2 or 3 months if you agree to buy it more cheaply than it is priced today.  (This price changes throughout the day, every day, so if it isn’t high enough for you, just be patient!)

*Note:  When you trade options, you buy and sell “contracts.”  1 contract always equals 100 shares of the stock.  Don’t miss this!  So when you start learning how to trade options, I recommend only selling one contract at a time.

6.  Now, click on Sell to Open Puts (or its equivalent) at the strike price and date (in 2 or 3 months) that you’d like.

7.  Always select “Limit” order to get a higher and better price for your troubles!  For example, if the current Put price is $0.50 (which equals $50 per contract), then it might be wise to set your Limit order at $0.55 or $0.60 (which means you’d make $55 or $60 per contract).

8.  That’s it.  You’re done!  The market will do the rest.  If the market thinks you’ve set a reasonable Limit price then the order will go through and you’ll instantly get the Limit amount deposited into your account.  If not, no big deal.  Just wait for another day to make another offer.  Eventually, the market will bite and you’ll be the person with the big fish!

In the future, check out Safe Options for Easy Income for my actual investment ideas.

Jeffrey W. Ross, MD is a Motley Fool investment freelancer.

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