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There are a number of options strategies that investors frequently overlook, some of which may offer equal or slightly better returns than straightforward equity positions (buying shares). Many options strategies are meant to compliment your already existing investment portfolio by using these compounding and profit-boosting tactics. One of the more popular ones I’ll be discussing today is the cash-secured-put (CSP for short).
A CSP is an option technique to go long on a stock or ETF you want to own, by selling the PUT option for a net credit and collecting the premium. One would do so by searching for stocks they liked, looking at the option chain and selling a PUT at a strike they like. This allows investors to effectively take a long position in a stock and receive compensation for it. This tactic is similar to selling insurance, like insurance, there are no free meals and this tactic is no exception to the rule.
There are a handful of downsides, such as missing out on dividend payments since you don’t technically own the stock, but I’ll mention only the most critical points as to why I do like the CSP and why I don’t. In point form, of course:
The CSP allows you to protect yourself to the downside, by collecting a small premium (usually 0.05%-3% or more depending on your risk tolerance). Essentially, if you are “assigned” the shares, you bought them at the discounted price after you collected the premium.
For the reason above, you should only be running CSPs on stocks you want to own, because there is a chance you will become the owner of these stocks.
Using this strategy you are receiving limited upside from selling CSPs. If you’ve allocated X amount of capital to receive a 2% gain from a CSP expiring in 4-5 weeks, and the stock goes up by 10%, then you’ve missed out on those potential gains as well.
Lastly, in strong downtrends and bear markets one CSP will leave you holding the bag for some time. However, it is still better than if you had bought those shares at the slightly higher price from not collecting premium.
Like I said, we are insurance sellers, and therefore, expecting a 50% yearly return from a put-selling investment alone would be unrealistic. But it also shows how much room for growth there is on a stock that technically doesn't need to move at all. The possibility of earning several percent per month and collecting premium is a great concept, but doesn’t mean it is guaranteed.
I’ll continue with stocks that I am looking at below.
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I’m going to show you some of my criteria for scanning stocks and then picking which one I want to run the cash-secured-put strategy on. There are two ways to run this strategy.
On Growth Stocks: anywhere from 2-4% return depending on IV, a volatility metric.
On Boring, Growing, Value Stocks: anywhere from 0.5-1.5%.
You can scan for potential plays using Barchart’s stock screener (no affiliate). It can be overwhelming at first, but it’s a powerful tool once you get the hang of it. Of course, there are other screeners and I’m sure your brokerage has one as well, but let’s use this free one for the sake of the example.
Here’s the criteria I set in my scanner before looking at each company:
Dividend yield > 1%
Revenue growth above 0% for last 1-3 years
EPS growth above 0% for last 1-3 years
Optional Criteria:
Net income growth for last 1-3 years
Low debt
Good current ratios
Check P/E (lower better, check industry averages)
Growing dividend
After all of that, I want to be able to have confidence that I can get assigned shares that I can hold for some time. I can also buy these shares and sell covered calls against, which would be nearly identical in return. So what’s on this list from the current scan? Names like:
Johnson & Johnson (JNJ)
Taiwan Semis (TSM)
Walmart (WMT)
Home Depot (HD)
Pepsi (PEP)
Qualcomm (QCOM)
The list goes on and on of “boring” companies, just as it should be. The returns on these companies are not as exciting as gambling on a growth stock, but the return may be worth the significantly less risk-profile. At 1% per month and roughly ~12% annualized it’s not a bad move, considering the market returns 9% per year on average. The option I was referring to was a 4-week until expiration PUT option being sold at the money (ATM) on Walmart (WMT), but most names on that list will provide a 0.5-1.5% return.
If you are interested in more growth names. Like this post, reply to this email, or leave a comment below so I can gauge your interest.
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