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Editor’s Note: Due to onscreen examples and demonstrations, it is much more effective to watch the video then merely read the transcript on its own.
TRANSCRIPT
Welcome to the Dividend Multiplier put selling tutorial video. I’m Marc Lichtenfeld. Today, I’m going to show you how to sell naked puts. It’s a very simple trade. We’re doing this on thinkorswim software by TD Ameritrade, but you can do it on any trading software or broker’s website.
What I – and many brokers, who offer it on their sites – like about this particular software is you can trade paper money, or make simulated trades. That way, you can follow along without risking any of your own funds, getting used to the mechanics until you feel comfortable to make the trades on your own. It’s a great way of getting familiar with Dividend Multiplier.
If you’re following along in the video, please take note where it says “cash and sweep vehicle – $100,000” up at the top. That number will be important later.
Okay, so we’re going to sell a naked put. You should already know that your broker needs to approve you to make that kind of trade. It’s a level 3 approval, so if you don’t have that yet, contact your broker and get approved. It shouldn’t take that long to do so, but you can paper trade while you wait.
We’re going to sell naked puts on Bristol-Myers Squibb, with the symbol of BMY, as our example today. Let’s look at the January $60 puts. Now, when you look at an options chain of puts and calls, the puts will be on the right side and the calls on the left. That’s pretty much standard.
The reason we’re going to choose $60 as the strike price is that, when we sell naked puts, we want the strike price to be below the current stock price. And you should only sell puts on stocks you want to own at a lower price. So don’t get tempted by some juicy premium that’s going to bring in a lot of income on a stock you don’t want to own. Keep in mind there’s a chance you could own the stock if the stock price goes down. If it falls enough, the stock could get put to you, which means you’d have to buy it.
This is really like being an insurance company. When you sell a put – let’s say it’s $60 – there could be somebody who owns the stock at $64.50 but is concerned it’s headed down. So they buy insurance in the form of a $60 put. They know that if the stock tanks, no matter how badly, they can sell their stock at $60.
As the person who sells the put, you’re the insurance company. You have to cover their loss in the case of a disaster. So if Bristol-Myers Squibb gets caught doing something illegal and the stock goes down to $30, you’re on the hook for buying it at $60. It’s really important to understand that you have to sell puts on stocks that you want to own at the prices you want to own them.
Now, when we sell puts in Dividend Multiplier, we usually sell when the strike price is a little further out than in this example. If we were selling puts on Bristol-Myers, we might sell it at a $55 strike price or maybe even $50. That way, there’s a pretty small chance of the stock getting put to us.
Another thing you should understand is that, if the stock goes below the strike price, it doesn’t automatically mean you’re getting put the stock and you have to buy it. At expiration, if the stock is below the strike price, you’ll have to buy it if you haven’t bought back the put already (which you can do before expiration). But at expiration, if the stock is below your strike price, you’re going to have to buy it. If it’s below the strike price before expiration, there’s a good chance you won’t have to buy it. Usually – not always – but usually, stocks are not put to their sellers until expiration. But be prepared anyway.
Now, here’s what we’re going to do. We’re selling the January 2016 $60 put, which means that at any time between now and the third Friday of January (options expire on the third Friday of the month), we’re willing to buy Bristol-Myers Squibb at $60. At last check, it was trading at $64.54, so if we were selling this put, that means we want to own Bristol-Myers at $60.
Let’s say the bid on the put is $1.32 and the ask is $1.59. This means you would sell it at $1.32 and buy it at $1.59. ($1.43 is the last trade on the screen.) Remember that an option contract is 100 shares, so $1.32 is actually $132. If you saw a price of $0.50, that’s $50; and if it’s $2.10, that’s $210 because you’re buying or selling in 100-share increments. That’s really important to understand. If we were going to sell one $60 put, we’d make $132. If we sold 10 $60 puts, we’d make $1,132.
So all we have to do here is click on the “bid” button. The order then comes up for “single sell 10 contracts Bristol-Myers Squibb January 2016 $60 strike price put.” Keep in mind that 10 contracts control 1,000 shares. That means if we got put 1,000 shares of Bristol-Myers, we’ll have to buy $60,000 worth of stock. So make sure this number is what you want it to be. A lot of times, the default is 10, but that’s too much for a lot of investors. You might want to collect that $1,132 in income, but you have to be ready to pay the price if it gets put to you. And you also have to have enough in your account to cover the margin requirements.
We’re going to change this to two contracts. We only want to buy 200 shares of Bristol-Myers at $60 if the stock gets put to us, despite believing it won’t. So we’re selling two contracts of Bristol-Myers January 2016 puts with a $60 strike and a limit order of $1.32. Now remember, when we saw that spread was wider, we could come in and change it. Let’s say it was a $1.32 bid and $1.59 on the ask. Let’s try to make it $1.45 and hit “confirm” and “send.” In this case, I’m just going to make it a market order. (Note: A lot of times in Dividend Multiplier, I’ll say a specific price such as “sell the January $60 puts, and be sure to get at least $1.30,” in which case you put $1.30 as the price.
After you hit “confirm” and “send,” all the information you need shows up. So you can see how your maximum loss is $11,709. That’s because 200 shares at $60 equals $12,000, and you’d get $291 as payment for the option. Factor in commission fees, and you’re looking at more like $289. If the stock went to zero, you would lose the $12,000 but still get to keep that $289.
I’m going to hit “send” to get us filled. And now it’s time to bring up that $100,000 I mentioned before. If you’re following onscreen, you can see how that number changed to $285.97 after we sold our $100 puts. That money is yours immediately: instant income. The only responsibility you have is, between now and the third Friday in January, you’ll have to buy the stock if it gets put to you at $60.
It’s really that simple. You can do these kinds of trades all day. Dividend Multiplier will provide several a month for you. You just have to make sure you have enough money in the account to buy the stock and enough money in margin to cover the trades. It’s really that simple. And all that instant income comes right into your account. We’re going to be selling puts with strike prices that are pretty far below the stock price. So while it’s not impossible that you’ll get put your position and you’ll have to buy the stock, it’s not that likely. We’re trying to avoid that happening.
It’s therefore a great method for achieving some instant income and generating a little bit of yield for your portfolio when yield is very difficult to come by these days.
If you have any questions, email me at feedback@oxfordclub.com and I’ll answer them in an upcoming alert.
Thanks for watching and keep an eye out for my alerts.