How To Generate Income Like a Wall Street Guru
For several years now, I’ve been telling readers how to use options to generate thousands of dollars in “Instant Income.”
Simply put, I think it’s one of the best income strategies in the world. But don’t take my word for it… one of the most well-known investing gurus around agrees.
Jeremy Grantham may not be as well-known as Warren Buffett, but he’s a well-respected name in finance. Noted for being a value investor and cofounder of GMO, a private investment firm with more than $60 billion under management, Grantham and his firm have turned to selling put options to generate market-beating returns.
In their latest letter to clients a few years ago, the co-head of GMO’s Asset Allocation team wrote about the firm’s 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 was 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.
Grantham may be best known (at least among investment geeks) for providing a detailed forecast of what he expects markets to do in the coming years. He is described by some market watchers as a “permabear” — because he almost always expresses his skepticism about the market and asset prices.
But instead of telling their clients to simply expect lower returns, GMO says they will sell put options to help them generate income.
How Put Options Can Juice Your Income
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, that’s okay. 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 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 sold put options and earned $7.5 million in income — all without buying or selling a single additional share of stock.
In the past few years, other mega-investors like Grantham took 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.
Action to Take
Outfits like GMO using put options confirms what I have always believed. When used properly, selling puts is no more risky than owning stocks. The advantage of selling puts is that you get paid to accept market risks.
Writing options is a conservative investment strategy that should be used by more individual investors. That’s why I’ve devoted my career to this strategy, and it’s also why I’ve been able to generate more income than I ever did during my time in the military. If you haven’t considered this strategy before, perhaps it’s time to start.
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