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Why selling puts against dividend paying stocks is a win-win strategy

There is a simple answer to this question, but I will make it a bit longer and complicated. It may be difficult for novice investors to engage in options trading, because from everywhere around us we keep hearing how dangerous options are.

Financial advisors of all sorts will tell you that options are very dangerous, you may lose money, it is a gamble, it is not for average investors, you shouldn’t trade options with your retirement money, and much more or similar nonsense.

Mostly, people who are discouraging you from trading options have never traded options. They are just playing their old scratched record they have been taught at their last seminar.

And brokers? Unfortunately they have to tell you that because the law forces them.

Trading options doesn’t mean jumping into complicated advanced strategies. A simple put selling strategy is enough to make you profits others will never believe you can make.

If I tell you that I have been making in average 45% profits annually in my last three years selling puts, you will not believe me and you will think about “too good to be true” thingy.

And yet it is possible to reach those numbers and without taking enormous risk with your money. One way to reduce the risk is trading options against stocks you want to own. And as a dividend investor, which stocks do you want to own?

Making money
(credit: Business Insider)

If you understand basics of options, how you can make money using them, you will find out, that trading options is very easy, simple and not risky at all. The best way to find out for yourself is to take a small trade and try it. If you do not want to commit your own cash trade in a paper money account first. I did it myself recently even after two years of trading I still use paper money account to practice trading. My small account doesn’t allow me trading as often as I wish, so for the rest of time I use paper money account.

Trading options, and in our case selling puts is all about an investor’s mindset. If you let your mind thinking how dangerous it is and never try even on your paper money account, you will miss a great opportunity of your life. I understand that it is not easy to get into a mindset of an option trader. I have been there myself. It is difficult at first when your understanding about options is limited. But do not worry, you do not have to make it complicated.

How to change your mindset to an option trader?

There are a few steps you can take and repeat yourself as long as you become comfortable with them. I did it myself a couple of years ago when looking at trades I would take.

A rule number one – sell puts against stocks you want to own – dividend stocks.

Rule number two – choose a strike price you are OK to pay for the stock in case you get assigned (when you will be forced to buy a stock)

Rule number three – if you have a small account and cannot afford more contracts than one, choose as long expiration as possible to collect at least 1.00 in premiums (before commissions). If you can afford more contracts you can choose shorter term (I like 56 days) and go with a smaller premium (for example 0.38 – see my latest trade of MSFT).

Rule number four – check the stocks supports and resistances, is the trend bullish? Will it last? Do you have a bullish or bearish expectations? If you are bullish, go ahead and sell the option. If you are bearish on that particular stock, go and choose another stock or wait for the bearish trend to finish and then sell the option.

Rule number five – sold your option? You collected a premium then. Never give it up! Defend it! Were you wrong on your assessment and stock went down? Do not worry, if the stock went ITM (in the money, meaning below strike) you have two options how to defend your premium:

  1. You do not want the stock yet – roll the option down.
  2. You do not want to bother with rolling options, take the stock.

Rule number six – never buy options. Always sell them. Have time decay on your side, not against you. You can buy options only as a part of a spread, or when you are really 100% sure that a certain stock will go down or up. But who is 100% sure today, right? People buy puts as protection, but even then you need to be 100% correct or you will lose all you paid for the option.

What you need to know?

First, you do not have to know anything about Greeks behind option prices, valuation, or movement. All you need to know is what option is and how you can use it. All other stuff is just a noise.

Options Greeks

Second, you want a watch list of stocks you want to trade.

Third, you need a broker’s approval for trading options.

Fourth, you need a good platform. I like ThinkorSwim platform, but you can use any other platform

Fifth, you need cash for cash secured puts or margin approval for naked puts. I prefer naked puts as I can use other people’s money to trade. But with naked puts when using margin, be sure you have enough cash anyway to potentially cover your assignment. It would be unpleasant being put a stock and not having money to buy it. That’s when losses can become large.

So what is an option?

Since I am talking about puts, let’s take a look at puts. A put option is a right to buy or sell a stock at a certain price (strike) at a certain time (expiration).

Every option is a time sensitive instrument. That means that as it is getting closer to expiration, its value is becoming smaller and smaller as long as it gets to zero, but only, if the option is out of the money. And this is the main reason why I do not buy options, but sell them. When you sell an option you get paid. You receive a premium.

By selling a put option to a guy on the other side you sell him a right to sell you his stock at a certain price at the time of expiration (and sometimes even earlier). That means that if you sell a put option with $20 strike price and 3 months left to expiration, you are selling a right to a person on the other side of the trade to sell you his 100 shares for $20 a share three months from now. If the stock falls to $13 a share, you will have to buy 100 shares for $20 a share. For this inconvenience you will get paid. You will get paid a premium.

Stock options

And here you may say: “ouch”, I do not want to buy a $13 stock for $20! It is a loss!! What a risk! I can lose money! The advisors were right! And you freak out.

This is a reason why I trade options (sell puts) against dividend growth stocks. Dividend growth stocks are mature companies and it is very unlikely that they would fall dramatically in price during market panic.

If they happen to fall during a sell off (like a few years ago JNJ dropped for no reason* to $56 a share) they tend to recover pretty quickly or if not quickly over a course of a few years (again check the chart of JNJ as it went from $56 all the way up to $100 a share).

* There actually was a reason. A few products of JNJ were recalled by a company and investors freaked out about it. It was a ridiculous sell off, which offered great opportunity to buy.

So if any of the panicked investors out there decides to give up their stock (use their right to exercise their option) and assigns you to a stock like JNJ, will you be mad? Will you consider it as a loss?

If your option gets in the money at expiration and you decide not to roll to a lower strike but accept the stock, you will be forced to buy at strike price minus premium a share. And you start collecting dividends!

When selling puts against dividend stocks, there are only two possible outputs:
 

  1. An option expires and you keep the premium.
  2. An option doesn’t expire worthless and you get assigned to a dividend paying stock, so it is a win-win situation, isn’t it?

 

There are options traders out there who are very successful and they trade options for a living. One of them is a self-made multi-millionaire Teddi Knight from Ontario in Canada. You can find information on her website fullyinformed.com

Have you ever heard about “Karen the Supertrader”? Karen is another self-made millionaire who learned trading options and made millions. She started with $100,000 account and turned it into $41 million in three years! And she is using a simple naked put & call selling strategy (unprotected iron condor – 1 short OTM call + 2 short OTM puts)
You can watch a video with Karen being interviewed by Tom Sosnoff in Tasty Trade:

 


Trader – Made $41 Million Profit in 3 Years Option Trading

 

Karen the Supertrader could do it. Of course, it took her circa 5 years before she found her strategy and mastered it and then another 3 years to turn her account into a fortune. She is now my role model trader. I will do all in my power to find out my own strategy to multiply my account the same way. Since I started with less money, it will take me longer. Now I must increase my account from current $18k to $100k and then to millions. In three years!

Tell me, do you trade options or consider trading it? Are you afraid to start? I was afraid as a hell, but as time went by I realized how easy it was. If you need any help, write me an email and I can help you with a trade set up and you can learn and start your own money making machine – collecting dividends and options premiums.
 
 





29 responses to “Why selling puts against dividend paying stocks is a win-win strategy”

  1. David says:

    I would like to know , is it better to own a stock like AT&T paying 5% dividend and then consistently sell “covered” puts

    Does that make sense ?

    What group are you guys talking about joining

    Maybe I haven’t read the original post

    Thanks

    • Martin says:

      Owning a stock will not make your puts “covered”. Only calls can be covered by a stock, so you can own AT&T and be selling covered calls or if you want to still generate income, you can be selling covered strangles. That means that you own 100 shares of ATT and sell a call and a put. Your call will be covered by 100 shares you own and to cover your puts you will need cash. If you are in a cash account, you will need entire purchase price cash equal to the put strike. If the stock goes up, your calls will be exercised (if in the money) and you will sell 100 shares of ATT and your puts expire worthless. If the stock goes down, your calls will expire worthless, you keep the stock and your puts will be exercised and you will have to buy another 100 shares of ATT, so now you will own 200 shares. You can then sell 2 covered calls and go on.

      The group is a Facebook group here https://www.facebook.com/groups/putdividends/

  2. Stan says:

    Very good article. Especially like the 1st “what you need to know” In my mind, the “greeks” are nice to know but in terms of making consistent profitable trades, choosing the correct underlying stock(s)is far more important as far as put selling is concerned. The authors (6) rules are excellent advice. I have been selling puts for years. Works great in a sideways market. My only word of caution would be careful regarding how many puts you are short at any given time. A huge market sell-off would result in owning more stock than one would desire or incurring significant short-term losses tring to close positions.

    • Martin says:

      I agree with you that knowing Greeks is not important. I have been trading options for 5 years and never used Greeks beyond observing Delta and Theta in determining whether I will be early assigned or not. That’s it. The underlying stock and strikes are important, but what is even more important is to know what you will be doing when the trade goes against you and you do not even have to predict whether you will be right or wrong.

      Thanks for stopping by!

  3. Pete says:

    I would like to join your group. Selling puts to buy Dividend stocks is my main approach to my active investing. Just Sold 2 COP Jan 18 42 puts OTM for $1,051. One thing I am not clear about is when in trading does one have to pay a dividend?

    • Martin says:

      Hi Pete, you would have to pay a dividend if you are short the stock. Options do not constitute the right nor obligation to dividends or other rights (such as voting) as the stock does. So if you sell a stock you do not own prior to selling then you will be obligated to pay dividends.

      Definitely join our group and follow our trades or post your own for others to follow you.

      Thanks for stopping by.

      Regards,
      Martin

  4. Jag says:

    Hi Martin
    Excellent to the point real experience base article. Thanks.
    May I find out before you put the trade can you talk about steps by steps process you go through to come up with the trade including looking at the chart, technical indicators you use for over sold over bought, trand etc. Like Karen she uses strike price at 5% Delta. What delta you use? And do you use naked put or spread and number of contracts you use as your trading fees are less so who is the Prefered broker you use. Looking forward to hear from you thanks a million.
    Jag

    • Martin says:

      Hi Jag,

      I would recommend you to join our Facebook group where we post our trades (other traders too) and explain all your questions there. Basically, though, I do not limit myself by delta anymore. I no longer trade SPX spreads where delta had its significance. I trade options against stocks and do not mind opening at the money trade or near the money trade with delta around 30, 40 or even 50. It depends on the trade of course, and my expectations.

      So, I trade against stocks, dividend paying stocks,and I trade primarily naked options – both puts and calls – strangles, sometimes straddles, lizards (or put or call ladders), etc.

      I use Dough.com (with TD Ameritrade) account, so my fees are low (around 1.50 per contract and no ticket fee). But as I said, join our group at https://www.facebook.com/groups/putdividends/ and the entire strategy is described there saved in the files section, plus you can see what we trade and eventually mirror it on you paper money account to see how it works.

      Regards,
      Thanks for stopping by and commenting. Appreciate it!

  5. Robert Cardone says:

    Very good article and encouraging. How can one know which dividend stocks are good for this strategy? I have read that Cisco is now considering a dividend stock.

    • Martin says:

      You build up a list of the dividend stocks and then check their options. Exclude those which are thinly traded, trade those which have nice options. Out of my list of 30 dividend stocks I now have approx. 4 which are excellent to trade and approx. 10 which are good to trade.

      • Robert cardone says:

        Thank you for responding to me I really appreciate it. So on the slowest of 30 or so stocks you do not own any of them correct ?

        • Martin says:

          On my trading account no, I do not own them, unless I get assigned, then I own them for a while, collect dividends, and sell covered calls until I get assigned again and sell the stock. Then I start selling puts again.

  6. Duane says:

    Does your broker require that you have money in your account to buy the stock if the Stock goes below the strike price for the put you just sold?

    • Martin says:

      I have a margin account so no, they only require the maintenance (which is approx. 30% of the entire money normally needed to purchase the stock). In my ROTH IRA account (which cannot use margin) I have to have the entire amount in cash to cover the trade.

  7. John Smith says:

    Lawl karen the supertrader is being investigated by the SEC

    • Martin says:

      I know. It quite irony that she started with nothing, made tons of money and ended up in fraudulent activities. I hope I would never end up like that as it undermines all her claims and credibility.

  8. Ravi says:

    Hello Martin,
    Very nice article on put selling. I started with stocks trading 10 years ago and last 5 years I have been trading only options. I have been to futures as well. Now, I am concentrating on credit strategies including put selling. However, I find it tough to get more than $15 per contract. I have only $8,000 to support any margin requirement. So, I am doing both straddle and put selling. Looking at your past history, it appears that you are selling puts during the earnings season (based on symbols and #s against it) and I see only SWY or SPX as regular trading. Was this your strategy? Due to margin constraint, I am looking for a few stocks that I can trade for put selling on regular basis. Would you be able to suggest some.

    • Martin says:

      Hi Ravi,

      I stopped trading SPX as I couldn’t make money trading SPX spreads. I used to trade options with underlying stocks and made nice money, later switched to SPX, lost that money, so I am back to trading options against stocks and making money again.

      You can see all my recent trades in the My Trades & Income tab. I trade against dividend paying stocks in case I get assigned I do not mind buying those stocks, holding them, collecting dividends, and selling covered calls.

      So, trading against SPX was my strategy, but since it didn’t work, then it is not my strategy anymore.

      If you want, you can join our trading group on Facebook where other traders and I are posting our trades basically on-line before we place them (I usually post a trade in the evening before the trading day, others are posting even during the day), so it is not only my trades, but also trades of other members.

      There you can see what we trade, which stocks, what DTE, what premium, and how we manage those trades. And if you like the trade, you can mirror it on your own. I usually recommend to do it in a paper trading account if you want to see first how we are doing before you commit cash, but, our trades are real life trades so we are committing our own money, so you can take some trust in those trades. Nevertheless you still need to do your own homework and not just blindly copying a trade. You need to understand the trade, how you can make money and how you can lose money in that trade. If you don’t, we are there to help so you can ask questions.

      Hope this helps.

      Thanks for stopping by!

  9. Ken says:

    To maximize your premium when selling your puts, you want volatility to be high. I only sell options when volatility is above 80% of its range for the past year.

  10. ED says:

    I’m looking for some good option screeners for PUT Selling strategy…Not a platform like ThinkorSwim, but good screeners on platforms like ThinkorSwim.
    Thanks,
    Ed

    • Martin says:

      ED,
      I do not use screeners. I have a watch list of stocks I want to trade options against them and then look for a good set up among those stocks. If I see a stock breaking down I sell calls, call spreads or buy puts, if I see a stock breaking up I sell puts, put spreads or buy calls.
      Screeners will not provide you with the whole picture and may be misleading.

  11. Nice write-up on selling puts. It’s my favorite options strategy and about the only one I use. If you just stick to the basics, like only selling against stocks you own/want to own, then you can take a lot of the risks away.

    • Martin says:

      Brent, I agree very much with you. I like put selling a lot too and when selling against stocks I like to own, all the stress is gone and it is a lot easier to trade. Thanks for stopping by and reading!

      • Daisy says:

        I love selling puts also and when the direction moves adverse, there is always and option to buy back if time has played in the favor or roll over to next month/period with lower strike price. Always a win-win strategy. I would love to help people by teaching them this.

        • Martin says:

          Thank you for commenting. You can join our group of traders on Facebook and help novice traders who are just following or watching our trading, or you can contribute in this blog if you want.

          Definitely, trading options is a great tool and I believe all investors should learn it and use it.

          • Warren says:

            You set the expiration dates a week to 3 out instead of a couple months

            • Martin says:

              Generally yes. But it depends on the stock and my account.

              So stocks with not rich premiums short term and in my ROTH IRA account I trade them between 30 to 45 days to expiration.

              In my trading account I trade 1 to 3 weeks expiration trades. But this is a different strategy. I do not own the stocks in this account and also prevent owning them if possible. This post is not about this account but rather my dividend investing account in ROTH.

              Thanks for stopping by!

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