As I announced on Twitter and Facebook page on Friday I planned opening new options trades on my favorite stocks – Safeway and Corning Int. (GLW). Both companies pay dividends, have grown them for several years and I am OK owning the stocks in case I get exercised.

That’s the beauty of put selling strategy against stocks you are OK to own. When the puts expire worthless, fine, you keep the premium and sell another put option next time.

If the option ends up in the money, you get exercised and will be forced to buy 100 shares of the stock at the strike price.

But it actually is not the strike price you pay. Although you literally pay the strike when buying the stock, you have to subtract the premium you received from the price. Thus actually you are buying your stock a lot cheaper than the strike.

And imagine, you are lucky enough that you happened to sell several puts before you got assigned. Then your cost basis is even lower than the current price!

Of course you may not be as fortunate as I was so far and you may sell a put option against a stock, let’s say at strike 20 dollars a share and the stock rapidly falls to $5 a share. You get exercised at 20 dollars a share while the current price is at $5 a share and the premium you received would be only 1.3 dollars.

Your purchase price will be 20 strike – 1.3 premium = 18.7 and the current price is only $5. Ouch. That may hurt. But that may hurt only, if you are selling against volatile, small caps, growth companies (which sometimes I do, to get some adrenaline to my blood stream). But this will unlikely happen to large cap dividend paying companies. Unless they cut the dividend you probably won’t experience such a huge price drop to be worried about getting exercised at substantially higher strike than the current market price.

I was selling puts against SWY for some time and in my spreadsheet where I keep records on my trades I usually add all my trades towards the future stock purchase price. Although I treat each put selling trade as a separate and independent trade, all proceedings go towards the cost basis.

What do I mean? Well, today SWY market price is $33.04 a share. But since I sold a few puts already, all of them expired worthless, my price of this stock is only $28.29 a share (and that is also my break even point). See the list of the trades to make it clearer:

+2.20 sold put in March 2013
+0.35 sold put in September 2013
+0.40 sold put in October 2013
+1.80 sold put in November 2013
——————————-
=4.75 total premiums received

A current price 33.04 – total premiums received 4.75 = break even 28.29 a share.

Even if I get assigned tomorrow, I will pay $33.04, but I have the premiums which will offset my purchase price. I already received the premiums and no one can take it away from me. My SWY stock will be profitable unless the stock price falls below 28.29 a share.

And the same will be with GLW stock.

The current market price is $16.78 a share, but my price is $12.59 a share.

Here are the trades I opened this morning:
 
 
11/18/2013 09:30:32 Sold 1 GLW May 17 2014 17.0 Put @ 1.33
11/18/2013 09:32:02 Sold 1 SWY Jan 18 2014 34.0 Put @ 1.8
 
 
Will those options expire worthless or will I buy shares? I do not know yet and I do not mind both outcomes. I am fine having these dividend payers for even cheaper price than the market can offer these days.

What about you? Do you like an idea selling puts to generate income which you would use to purchase your favorite stock or would you rather stay away from options?