Today I'd like to dust off one of our favorite strategies for dealing with a pullback: getting paid to buy stocks at a discount.
If you've followed along with StreetAuthority Daily for a while, then you're probably familiar with my colleague Amber Hestla and the put-selling strategy she uses in her premium newsletter, Income Trader.
For those that are unfamiliar, you can in effect get paid for the chance to buy stocks at a discount by utilizing a conservative strategy that involves selling put options contracts.
And in a market making new all-time highs week after week, I don't have to tell you that the available "discounts" on quality companies are far and few between.
Here's how it works.
|Is This Taking Income Investing Too Far?
Our team has done something unusual. We've created a retirement portfolio with only dividend-paying securities. Have we taken income investing too far? Click here to decide for yourself.
Let's say you really want to buy software giant Microsoft (Nasdaq: MSFT). But at a recent price of just over $57.50 per share, you feel like the stock is a little expensive. At that price, the stock has a price-to-earnings ratio of 27.6, which is pretty rich when compared to its five-year average of 20. Consequently, that P/E is also a good deal above the broader market's current valuation (the S&P 500's P/E is about 20).
You'd feel a lot more comfortable about buying if it were trading for less -- like, say, $52.50, which is about 8% below the recent price. At that level, sure, the stock would still be a little rich, but you could live with it. After all, we're talking about Microsoft. It's a good company. It's not going anywhere.
Now, you could place a limit order to buy MSFT at $52.50 a share. After all, it's not unthinkable to see a pullback in the market or some other event that causes shares to drop to your preferred buy price within the next few weeks or so.
Perhaps you'll find some place to park your cash in the meantime and earn a little bit of interest while you wait. Then again, in today's low-interest rate environment, that's unlikely.
Forget that. Do yourself a favor and don't allow either of those options to back you into a corner. If you really feel that uncomfortable with Microsoft's current price, then I'm here to tell you that you have a third choice: Selling put options.
Put options give the owner the right -- but not the obligation -- to sell a stock at a specified price before a specified date.
Using the example above, you could sell a put option on Microsoft with a "strike price" of $52.50 that expires on October 23 for a "premium" of $0.54.
That means if MSFT falls to $52.50 or below by October 23, you'll scoop up shares at an eight percent discount to current prices.
The premium, or what Amber calls "instant income," is what you receive from writing the option -- in this case, about $54 per contract. And it's yours to keep no matter what. (An option contract controls 100 shares. So: $0.54 x 100 = $54.)
When you sell a put, you are obligated to purchase that stock from the put buyer if shares fall to the specified price (the option's "strike price") -- in this case, $52.50 per share. But remember: that's the discounted price you wanted to pay for shares of MSFT in the first place. And because you already pocketed a premium for selling the put, your cost basis is actually $51.96 ($52.50 (strike price) - $0.54 (premium per share) = $51.96).
And if MSFT doesn't fall to the strike price before October 23, you are no longer obligated to purchase the stock, but you keep the $54 premium.
What's great about this strategy is that you get paid to set the terms. You decide what you'd be comfortable paying for a stock should it fall to the specified price. And you set the timeframe that you're willing to wait. It lowers your cost basis (if the stock falls to your strike price, as noted above) and if it doesn't fall to your specified price, then you simply keep the premium.
What's more, you can repeat this process again and again -- and scale it up depending on your comfort level.
As we've said before, selling puts is about as close as it gets to a win-win in investing. In fact, since Amber launched Income Trader in 2013, she's managed to post an astonishing 134 winning trades out of 140. That's a win-rate of 96%.
If you're not familiar with options, but this "win-win" strategy sounds intriguing to you, then we have a special presentation that goes into more detail about Amber's strategy. And if you choose give Income Trader a risk-free trial, you'll also get a full slate of reports to quickly get you up to speed on options trading. To get started, go here now.