Imagine this:
You see a stock you like.
It’s trading for $50 a share.
You want to buy it for $45 per share.
So you simply tell your broker – “Hey, I want to buy that stock for $45 per share”.
And your broker says, “Sure! If it falls to $45 per share, we’ll buy it for you. And we’ll pay you $10 every week while you wait.”
Sounds too good to be true, right?
It’s not.
I know, since I’ve made about $300 USD this month doing exactly that.
This isn’t even a secret.
It’s a well-known strategy known as cash-covered puts, which I’m going to explain to you right now.
Understanding Put Options
To execute this strategy, you first need to understand put options.
I have a blog post explaining them in detail here.
A put option is a contract that gives you the right to sell a share at a certain price.
For example, let’s say Microsoft is currently $300 per share, and you think it’s going to fall.
To bet on this, you could buy a 2-month $300 put option, which will give you the right to sell Microsoft shares at $300 any time in the next 2 months.
Then let’s say after a few weeks, Microsoft has fallen to $250 per share.
Great!
This means you buy shares at the current market price of $250, then exercise your put options to sell them at $300.
You make $50 per share
In short, a put option is a way to bet that the share price will fall.
You Can Both Buy And Sell Put Options
In the example above, we’ve talked about buying put options.
However, remember in the markets – for every buyer, there must also be a seller.
This means yes – you can also sell put options!
Let’s go back to our Microsoft example.
The $300 put options we bought – someone else had to sell them to us.
Say that guy’s name is Roger.
What does it look like from Roger’s side as the seller?
Roger sees the Microsoft share price at $300, and thinks it will keep going up.
Therefore, he sells the put options to us.
This means if we exercise our put options in the future, the person we will be selling to is Roger.
Why would Roger want to sell put options?
Well – the first and most obvious reason is, he makes money.
When we buy our $300 put options, we don’t get them for free. We pay for them – usually a few cents each.
If we buy options for 200 shares at 10 cents each, that would be $20 that we pay to Roger.
So from Roger’s point of view, the bet looks like this:
If the share price closes above $300 at the end of the contract, then the put options would be worthless, and Roger has made a clean $20.
If the share price closes under $300 at the end of the contract, we’ll exercise our put options, and Roger will need to buy our shares for above market price.
So How Do We Make Money!?!
Now you understand what put options look like for both the buyer and seller, we can get to the good stuff.
Here’s how we can make money with “cash-covered puts”.
First – there are two requirements:
- You must want to own the stock
- You must have enough cash to buy (at least) 100 shares
Let’s use Apple as an example.
The current Apple price is $184.94.
Say we’ve done our research and are interested in buying Apple for $175 per share.
Normally, we would simply place a limit order for $175.
If the price falls to $175, our order will hit.
However, there’s a better way.
Instead of placing a limit order for $175, we can sell $175 put options!!
That way, we actually make some cash while we’re waiting for the stock to hit our target price.
Below is the options chain for Apple:
You can see I’m looking at the 27-day options, which I’ve highlighted in green.
If we go to the $175 options, you can see the current bid is 64 cents per share, which I’ve also highlighted in green.
This means there are buyers offering 64 cents per share who we can sell to.
Remember – like I explained in my options guide, options are sold in bundles of 100 shares, so you will need to sell puts on at least 100 shares.
So here’s how it works.
We sell 100 put options for 64 cents each, meaning we’ll receive $64.
And then … we do nothing!
All that’s left to do is wait until the expiry date, which is 27 days.
There are only two possible outcomes:
- The share price falls below $175. This means the put options will be exercised by whoever we sold them to, and we will need to buy 100 Apple stock from them at $175. However, we wanted to do that anyway.
- The share price stays above $175. This means the put options will expire worthless. We simply keep our $64, and sell another round of puts to make even more money!
As you can see, the additional risk we take on is zero.
With outcome #1, we had to buy the shares above market price, but we were going to place orders to buy the shares at that price anyway. We haven’t taken on any permanent loss, and as long as we are buying-and-holding for the long-term, any paper losses should be temporary.
With outcome #2, we made $64 with no strings attached! And the best part is – we can do it again, and continue doing it until our target price hits.
Once again – for this strategy to work, you must have enough cash in your account to cover the puts if exercised (hence the name, cash-covered puts).
In this particular scenario, we would need enough cash to buy 100 Apple shares at $175, or $17,500 USD.
However, if you don’t have that much you can simply find a lower-priced stock.
For example, AT&T is $14 per share, meaning you would only need $1,400 USD.
Finally, you need a broker that offers options trading.
I use Interactive Brokers for all my US stocks and options trading, and am very happy with them! You can read my full review of them here.
You can also get up to $1,000 free if you sign up for your account using this link!
This is one of my favourite ways to generate income on my stocks, and I currently make around $100 USD per week simply selling covered calls and covered puts, while taking on very little to zero additional risk.
If you have a decent-sized portfolio of stocks, this could be another useful blue arrow to add to your empire.
Keep hustling!
