We are happy to present our first ever RVF guest post by welcoming Gavin McMaster of Options Trading IQ.
As readers of our blog know we are building a dividend portfolio with the goal of building it to a scale that allows us to sell covered call options to generate income. Gavin uses another approach that can also be used to generate income and/or build a position.
To many of our readers this might be a tool they are already using. But for others, myself included, this is something new and educational that could be useful as we grow our stock portfolio.
I will now turn the blog over to Gavin.
Thanks to RV-on-Fire for the opportunity to guest post here today. My name is Gavin, and I’m the founder of Options Trading IQ, one of the world’s leading option educators for retail traders.
I also write a daily column for Investor’s Business Daily, which you may want to check out.
Recently, I noticed that RV-on-Fire has Dividend Aristocrat ABBV in their portfolio, and I wanted to share a recent trade of mine called a cash secured put.
This is one of my favorite strategies for picking up stocks that I want to own, or achieving a healthy annualized return.
Selling cash secured puts on stocks an investor is happy to take ownership of is a great way to generate some extra income.
A cash-secured put involves writing an at-the-money or out-of-the-money put option and simultaneously setting aside enough cash to buy the stock.
The goal is to either have the put expire worthless and keep the premium, or to be assigned and acquire the stock below the current price.
It’s important that anyone selling puts understands that they may be assigned 100 shares at the strike price.
Why Trade Cash Secured Puts?
Selling cash secured puts is a bullish trade but slightly less bullish than outright stock ownership.
If the investor was strongly bullish, they would prefer to look at strategies like a long call, a bull call spread, or a poor man’s covered call.
Investors would sell a put on a stock they think will stay flat, rise slightly, or at worst not drop too much.
Cash secured put sellers set aside enough capital to purchase the shares and are happy to take ownership of the stock if called upon to do so by the put buyer.
Naked put sellers, on the other hand, have no intention of taking ownership of the stock and are purely looking to generate premium from option selling strategies.
The more bullish the cash secure put investor is, the closer they should sell the put to the current stock price.
This will generate the most amount of premium and also increase the chances of the put being assigned.
Selling deep-out-of-the-money puts generates the smallest amount of premium and is less likely to see the put assigned.
ABBV Cash Secure Put Example
On September 16th, with ABBV trading around $106, I sold a June 17th, 2022 put option with a strike price of $95.
For selling this put, I received $550 in option premium.
In return for receiving this premium, I have an obligation to buy 100 shares of ABBV for $95. By June next year, if ABBV is trading for $90, or $70, or even $10, I still have to buy 100 shares at $95.
But, If ABBV is trading above $95, the put option expired worthless, and I keep the $550 option premium.
The net capital at risk is equal to the strike price of 95, less the 5.50 in option premium. So, if I am assigned, my net cost basis will be 89.50. That’s not bad for a stock currently trading at $107.
That’s around a 15.57% discount from the price it was trading on September 16th.
If ABBV stays above $95, my return on capital is:
$550 / $8,950 = 6.15% in 274 days, which works out to 8.19% annualized.
I’m happy either way. Either I achieve an 8.19% annualize return, or I get to buy a Dividend Aristocrat stock for a 15.57% discount.
I use this handy calculator to run the numbers and make sure I am happy with the different scenarios.
While this type of strategy requires a lot of capital, it is a great way to generate an income from stocks you want to own.
If you end up being assigned, you can sit back and collect the fat 5% dividend on offer from ABBV.
You can do this on other stocks as well, but remember to start small until you understand a bit more about how this all works.
If you have any questions, feel free to reach out to me by email or on Twitter.
*Disclosure: On the date of publication, Gavin McMaster did have (either directly or indirectly) positions in the securities mentioned in this article.
Byline: Gavin McMaster has a Masters in Applied Financeand Investment. He specializes in income trading using options, is very conservative in his style, and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ
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