After reading my educational piece on how to sell puts and earn easy income, you may be ready to take a stab at it. Congratulations! You are on your way to financial independence and to earning significant extra income this year . . . and any year!
Using the template from my earlier piece, I will show you exactly how I would (and just might) sell to open naked puts this week . . . in 8 simple steps. Here goes:
1. Think of a great stock (company) you’d like to own, ideally one with a healthy dividend and a strong balance sheet. Today (10/15/2012), I’m thinking of Cisco (CSCO), the internet infrastructure king. It makes more money than it knows what to do with and it has become incredibly share-holder friendly in the past few years. It now sports a dividend of about 3% and a price/earnings ratio of 12 (with a forward P/E of only 8.8!). It’s a great company at a reasonable share price.
2. What is the current stock price? $18.41.
3. Would you like to buy it at a cheaper price? Yes!! Is this a trick question? (Note: this is not a trick question. Safe options literally give you this choice . . . you just have to claim it to collect the money!)
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. Got it.
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. I see that the Dec. 22, 2012 put is going for about $0.72. That means that if I agree to buy 100 shares* of CSCO on 12/22/2012 for $1,800, I will get paid $72 today.
*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. I did it (seriously, I just did!).
7. Always select “Limit” order to get a higher and better price for your troubles! I placed a Limit order at $0.80 (or, $80 per contract). If the market takes it, that’s great. If not, I’ll just be patient and wait for another easy income opportunity.
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! Sweet!
Jeffrey W. Ross, MD is a Motley Fool investment freelancer.