In Forbes Premium Income Report, we sell options for income. Sometimes we do what are known as buy writes, in which we buy a stock and simultaneously sell out-of-the-money call options against it. Other times, we sell out-of-the-money put options, which obliges us to buy the stock at the strike price if the stock finishes below the strike price at expiration. If the stock price remains above the strike price, we keep the money we earned from selling the options. Occasionally, we end up owning stocks after the options expire and we sell covered calls against the position.
Many subscribers have written to me with questions on the strategies we use and how best to utilize the service. In the interest of helping new and potential subscribers, I've listed five of the most frequently asked questions and answers below.
What would you say is a good cash starting point for beginning the ideas you mention in this newsletter? The average size of a recommended trade is about $6,000, and they range from $4,000 to $10,000. Because you have to buy at least 100 shares, or have cash set aside with your broker to buy it in the case of selling puts, you're looking at committing at least $5,000 to any stock that trades for $50 per share and above. For a several-hundred dollar stock like AMZN, NFLX or PCLN would require tens of thousands (about $125 K for PCLN) to get involved with the options, since one contract covers 100 shares. Since I recommend two trades every Tuesday and Thursday, that's 16 per month. Using my $6,000 average size, that comes out to $96k to get rolling for one month. Then when the options expire, mostly on the third Friday of each month, you have new cash to redeploy, or stocks to sell or hold. Kind of like farming. You could pick just half of the trades I recommend and $50,000 would be sufficient to get you going. Pick one out of four and $25,000 would be fine.
When selling put options, if the option is exercised, I am obligated to buy the security. Once I buy the stock, is there a minimum time that I have to hold the stock, or can I hold or sell the stock any time after the settlement date? Regarding having puts exercised, once the shares of the underlying stock are in your brokerage account, you can do whatever you'd like to do right away. What I like to do is to see what kinds of returns I can earn selling covered calls. If nothing expiring in the next few months provides at least a possible 15% annualized return, then I sit tight until something does develop while I'm hopefully collecting dividends, too.
Your website mentions selling covered calls. Is this a large part of your strategy? I don't own significant stocks so I can't participate in covered calls. The only time I send out a covered call recommendation is when it's on a stock that we ended up owning after a prior expiation. When I send out the recommendations they are considered good to buy at the prices shown or better. Sometimes we end up owning a stock after the options expire, but we do so at a reduced cost basis thanks to the money received from selling the options, and we can repeat the premium income cycle again by selling call options against the stock. I group the recommendations into conservative and aggressive depending on the risk of the underlying stock. Before you put in the order, check to see that the current bid price of the options we are selling is at or near the price quoted in the recommendation. This way, you won't put in a net debit limit order to do a buy write on a stock that has already tanked. You will probably get filled, but you'll be angry, because you could have bought the stock and sold a lower-strike call for more money.
Please explain the process for entering a buy write order. You can do buy writes a couple of ways. Most brokerages offer specific buy write orders in which you select the number of shares of stock you want to buy and which call options you want to sell. You can put in the trade as a market order, and this will likely have you buying the stock at the ask price and selling the calls at the bid price. If the bid-ask spread is tight, this may not be a big deal, but if you have a wide bid-ask spread, it may be more appropriate to use a "net debit limit order." The net debit is the amount you need to pay to establish the position, calculated as the price of the stock minus the price of the option you sell. By using a net debit limit you establish the maximum price you are willing to pay for the combination. If you want to sell call options for $1 apiece on a stock that trades at $30, you would use a net debit limit of $29.
Should I demand to receive the exact amount for the options I’m selling that you suggest or do I accept a little less income? What I am seeking is a 2% or so yield per month from the premium we collect dividend by the money at risk. If you can get that amount of premium, the trade makes sense. Always check the quote of the options that I recommend selling to see if you can sell them for more, or if you cannot get as high of a premium that I've recommended. Don't stray too many pennies from the recommended prices because if the stock has moved a lot, the better trade may be a buy write at a lower strike price, or a put sale. I would think of these recommendations as pitches, and you're the batter. If the pitch is not in your strike zone, you don't need to swing at it. Don't chase bad pitches. With two picks every Tuesday and Thursday, there's always another opportunity coming down the pike.
