In today’s market, it has become difficult for investors to generate income. Dividends are historically low, and it has become hard to find dividend stocks with generous payments without significant risk. Moreover, bond portfolios have suffered some of their worst years on record.

But despite the lack of “traditional” income opportunities, many great income strategies are available to investors. You simply have to be open to using “alternative” approaches.

One strategy we have written about at length is the covered call method. This allows us to sell call options against individual stock positions and collect extra income. Today, we want to introduce you to another income-generating options strategy.

It involves selling options against a stock we would like to own. Let’s dive in…

A Collector’s Story

They say a picture is worth a thousand words. When explaining a financial transaction, sometimes a real-life example is just as valuable. So, to illustrate how the put-selling strategy works, we will use an example that is not directly tied to the stock market.

Let’s say you have a friend who is a collector of high-end cars. He is interested, whether it’s a 1950s American muscle car or a limited edition Italian sports car. In fact, more than just a hobby, his obsession with collectible cars is a full-fledged family business.

Whenever your friend has his eye on a car, he takes an unusual approach to purchasing it. Instead of directly offering to buy the car from the dealer, he adds a little finesse to his strategy. Since this is a business and not just a hobby, he must buy all of his cars at an attractive price. If he pays too much, he’s likely to get saddled with an asset he can’t sell — at least not profitably.

So, instead of buying a car for its Blue Book listed price, your friend strikes a deal with the owner. He lays out a price below the current market value. He says that he is willing to buy the car for that price anytime over the next six months.

So, if a collectible car has an expected value of $60,000, he will offer the owner $55,000 anytime between now and the end of the year. Most car dealers like this offer. Because if they have made a mistake in their calculations or can’t find a buyer, they know your friend will at least take the car off their hands for a small loss. (It can be very expensive for car dealers to keep inventory that is not selling.)

There is one catch with this strategy. Instead of making this offer outright, your savvy friend requires the dealership to pay him $1,000 to keep the offer open. This way, if he doesn’t get to purchase the car at a discount, he still makes a little bit of money on the side. And if he does purchase the car, that’s what he wanted in the first place.

Your friend does not wind up purchasing most of the cars. Usually, the dealer can sell the car for a higher price, and your friend simply cashes his $1,000 check. But occasionally, he ends up with a car he can park in his garage, tinker with, and eventually sell for a profit.

This strategy is essentially the same concept used in a put-selling strategy.

A “Win-Win” Offer

To sell a put option means giving someone else the right (but not the obligation) to sell stock to us at a predetermined level. This means we must buy that stock if the owner elects to exercise their right. It also means that we are being paid for taking on that obligation.

This is a good way to earn extra income in your investment account.

For the most part, we like to use the put-selling strategy on stocks we want to own that have been beaten down. Like your friend, when we sell a put contract, we make an offer below the current market price for a specified amount of time. We expect that we will not have to purchase stock most of the time. Instead, we’ll just collect the premium from selling the puts, boosting the value of our investment account.

However, there are times when we will be obligated to buy shares of stock. This is why we prefer to use stocks we ultimately want to own and stocks that have already been beaten down. This ensures it will be in an attractive stock trading at a significant discount.

Closing Thoughts

One thing… Make sure you have enough capital to cover any potential stock acquisitions. If you are too aggressive and sell too many put contracts, you could end up with an obligation you do not have the capital to fulfill. Remember that each contract represents 100 shares. So, if you are selling a put contract with a strike price of $20, you need to have $2,000 available in your account if you are obligated to purchase 100 shares at $20.

Your account balance should grow steadily as you gain experience. A higher balance allows you to increase the number of contracts you can sell, resulting in an ever-growing (compounding) income stream.

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