An Income Strategy with Options – Part II

In yesterday's issue of HX Daily, we shared an options strategy that can help you both manage risk and generate some income for your portfolio.

At our hedge funds, we ran billions of dollars and actively used options for these same purposes. Across my career, I am sure we traded several billion dollars (notional) worth of options contracts.

As I mentioned yesterday, though, when meeting Doc Eifrig at Stansberry Research, I began to think about harnessing them for regular investors.

Doc has one of the most interesting backgrounds of any investment writer, and you can read about him here.

As we said yesterday, he has an incredible track record of making money for his readers with options. Super high hit rates (90%+) and win streaks that go on for YEARS.

Yesterday, we shared one of the options strategies; today, we share another.

This strategy underpins both Doc's incredible track record and our enviable track record with our HX Income product. Since launching it in February, our readers have made money on a similar 90% of recommendations.

The strategy is called "put option selling."

Remember that we explained that when you buy a "call" option, you have the right - but not the obligation – to buy a stock at a specific price ("strike price") and a particular time ("expiry date").

A “put option” is the opposite. When you BUY a "put" option, you have the right – but not the obligation – to SELL a stock at a specific price ("strike price") and a particular time ("expiry date").

We will use another real-world example.

We will use the stock of the biggest non-sovereign oil company in the world – Exxon Mobil Corporation (NYSE: XOM). We say "non-sovereign" because the three largest oil companies in the world are controlled by countries – Saudi Arabia and China. The largest privately owned company is XOM.

Here is the recent stock chart of XOM…

You can see the stock has sold off recently and is currently trading around $110 per share.

If you went out to buy the August 16, 2024, PUT options, you would be paying around $2.00 or $200 per contract.

This means that if the stock fell below $105, you could sell it at $105.

With the cost of the put option being $2.00, you would need the stock to go below a price of $103 before you would have "saved" money.

If you owned 100 shares right now and the stock traded to $100, you would lose -$1,000 (100 x - $10 per share).

Owning these put options, you would lose only 700 dollars. You could sell the stock at $105 and save $5, which you would lose if you just owned the stock. You also paid $2 for the options, so you would add the cost of your loss on the stock ($110 - $105 = $5) to the price of the options ($2) to get a $7 loss on the position. On 100 shares, that is -$700.

That is not much of a difference, but if you thought the stock was going to $95, $90, or even lower, the savings add up.

This is how put options are used to manage the risk of a position.

Like call options – a put option has both an “intrinsic value” and a “time value.”

The intrinsic value here is $0. The stock is trading (at $110) above the strike price ($105), so there is no value in exercising the option right now.

The "time value" is 100% of the option's value and is the $2 you pay in the example above.

Put options get more expensive when people get SCARED.

If a stock has just fallen a great deal in a short period – like XOM in the chart above – then the "premium" of an option usually goes higher. This makes it more expensive to manage the risk or “hedge” the position but also presents an opportunity for an investor.

Our HX Income TRADING strategy identifies high-quality stocks that have experienced a sudden sell-off. We look at technical and fundamental data to determine whether the stock has more downside.

This group of indicators has an exceptional track record of finding stocks near the bottom.

We do not have a formal recommendation XOM for this strategy. Still, it is precisely the kind of stock we are looking for with this strategy

: a leading global company with an excellent track record, a strong balance, and (often) a dividend. XOM pays a 3.5% dividend.

IF this were a recommendation in our strategy, we would recommend that you SELL those $105 August put options. This would bring you $200 of income.

If everything works out – and the stock price stays above $105 – the put option will expire worthless, and you get to pocket the $200 of income.

If the stock trades below $105, you will get “put” the stock and must buy the shares. This is why it is essential to have a thorough analysis of the stock.

If the stock price at expiration exceeds $103 (the $105 strike price minus the $2 premium you collected), you can quickly sell the stock and book a profit. That is smaller than the original $200 but still a profit.

If the stock trades below $103, you now own 100 shares of XOM.

With the stocks that we (and Doc) recommend, we are looking for situations where this last scenario is unlikely.

As importantly, though, we are looking for situations where, even if it DOES happen – you will be happy to own this high-quality stock at an attractive price.

If the right stocks are chosen, you have a strategy that can churn out great income and post great winning streaks.

This can be a great strategy, but it is best to partner with experienced partners – like Doc and myself!

Have you ever sold put options to generate income? Please share your thoughts in the comments section online or at [email protected].