News Analysis date published New: 
Thursday, February 21, 2013 - 08:30
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Thursday, February 21, 2013 - 11:38
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Thursday, February 21, 2013 - 08:30

Generate "Instant Income" Like a Wall Street Guru

Thursday, February 21, 2013 - 8:30am

A couple weeks ago, I told readers how investors are using options to generate thousands of dollars in "Instant Income."

Simply put, I think it's one of the best income strategies in the world.

And Jeremy Grantham, noted value investor and Chief Investment Strategist of GMO, a private investment firm with $106 billion under management, agrees.

Grantham and his firm have turned to selling put options to generate market-beating returns for his fund.

In their latest letter to clients, the co-head of GMO's Asset Allocation team wrote about the firm's innovative strategy, saying:

"Is there any kind of diversification you can get excited about? We believe there is. One clear example, which has made its way into our multi-asset portfolios, is equity put selling."

Why is this a big deal?

For starters, GMO is a value-based investing outfit -- not a flashy hedge fund using risky strategies to try and beat the market. And the fact that they're "excited" about it should be more than enough to get the attention of conservative investors.

Since 1985, GMO's U.S. Core Equities Strategy has delivered an average annual gain of 10.82% a year while the S&P 500 has gained 7.77% a year during that time. GMO attributes their success to "discipline, value orientation, investment research, and constant innovation."

Grantham may be best known (at least among investment geeks) for providing a detailed forecast of what he expects markets to do during the next seven years. His latest report shows that he expects large-cap U.S. stocks to provide an average real return of 0.1% a year for the next seven years. The outlook for small-cap stocks is even worse, with an expected average loss of 0.8% a year.

(Grantham isn't alone in thinking this. StreetAuthority Co-founder Paul Tracy has already gone on record saying he thinks that ALL of the market's returns during the next decade will come from dividends.)

But instead of telling their clients to simply expect lower returns, GMO says they will be selling put options to help them beat the market. And what's more, they're actually "excited" about it -- just like I am.

To recap, "put" options give investors the right -- but not the obligation -- to sell a stock at a specified price before a specified date. Selling a put obligates us to purchase that stock from the put buyer if it falls below a specified price (the option's "strike price"). When we accept that obligation, we receive "Instant Income" upfront (known as a "premium"). You can be asked to buy the stock at any time between the moment you collect the premium and the expiration of the option contract.

Now, one thing I do to lower the risks of trading is to only sell puts on stocks I would want in my portfolio anyway. So if I make a trade and the stock falls below the strike price, obligating me to buy the stock, I'm buying shares of a stock I wanted to own anyway, and for a better price than it once was.

This is the same exact strategy Warren Buffett used to acquire his initial stake in Coca-Cola (NYSE: KO). The King of Buy-and-Hold first bought shares of Coca-Cola in 1988. At the time, Buffett said he expected to hang on to this "outstanding business" for "a long time."

However, the world's greatest investor is also a bargain hunter. If Buffett likes a company, but believes its share price is too high, he'll wait until the market "cooperates" before he'll buy more shares.

But the stock wasn't correcting, so Buffett decided to use the power of options.

By April 1993, Buffett's beloved Coca-Cola was trading at about $39 a share (before two splits) -- a price he regarded as too expensive to buy more shares at the time. But did the self-made billionaire let his cash sit idle while waiting for a downturn? Not a chance.

Buffett employed an options strategy that earned him $7.5 million in income -- all without buying or selling a single additional share of stock.

And now other mega-investors like Grantham are taking a page from Buffett's playbook by using puts to earn extra income. But it's not just billionaire investors who can use this strategy -- everyday investors like you and me can use it, too.

Selling puts, GMO notes, is no more risky than owning stocks. The advantage of selling puts is that you get paid to accept market risks. The folks at GMO believe that selling puts is especially attractive right now, when the market appears to be overvalued.

That's especially true with the S&P 500 at five-year highs and average dividend yields near record lows at 2.1%. By selling puts, we can generate steady income and ensure we never overpay for stocks.

Action to Take --> GMO confirms what I have always believed. Writing options is a conservative investment strategy that should be used by more individual investors. That's why I started my Income Trader investment service. Each week, I walk investors through a trade, showing them how to use simple strategies like selling puts to generate "Instant Income." To learn more about my "Instant Income" strategy and how it works, click here to view this special presentation.

Amber Hestla does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.