My Favorite Low-Risk Strategy Is So Easy My Kid Can Do it

Last week, I was pretty blunt… I told you to:

STOP GAMBLING.

Instead, find a strategy that puts the odds of winning on your side.

In other words, find a way to be the casino – not the gambler. Find a way to turn the casino into a cash register.

So today, I’m sharing one of my favorite low-risk option trading strategies with you… and stick with me… it’s simple enough that my college-aged son can do it…

The Cash Register

And that’s selling uncovered put options.

It converts the “casino” atmosphere of the options market to a cash register. Instead of gambling, the seller of uncovered puts collects cash up front for every trade.

Here’s how it works…

By selling uncovered puts, a trader receives a cash premium for agreeing to buy shares of a stock at a specified price by some future date. The reason they’re “uncovered” or “naked” is because the trader doesn’t have a position in the shares of the underlying put option contract. So he’s taking on an obligation without having the stock.

With this strategy, the trader isn’t necessarily betting on a rise in the stock price. They’re just betting it won’t go much lower. And, if the share price does fall, they’d be willing to buy it anyway.

That last part is important: You should only sell uncovered put options on stocks you’d like to own, and at prices you’d like to own them.

Think of it this way…

Imagine you walk into your favorite department store and notice the sweater you’ve had your eye on for a few months is now marked down to half-price. Instead of having to fork over $100 for the sweater, it can be yours for just $50.

“What a deal,” you think to yourself. “But, I’d so much rather pay $40.” So you walk over to the clerk behind the cash register and tell him, “I’ll happily buy that sweater from you if it goes on sale for $40 within the next three months.” The clerk opens up his cash register, grabs a $5 bill, and hands it to you. “You have a deal,” he says.

You walk away with the $5 in your pocket, and an agreement to buy a sweater you want to buy anyway at 20% below the sale price.

Three months from now, if the sweater never gets discounted to $40, your obligation expires and you keep the $5 the cashier handed you. If the sweater is on sale for less than $40, you’re going to pay $40 for it anyway – which you were willing to do in the first place – and the $5 you received lowers your actual cost to just $35.

You’ve Got a Deal

The important thing here is you have to actually want to own the sweater, and you have to be willing to pay $40 for it.

If you don’t like the sweater, or you think $40 is still too much, then you don’t make this deal in the first place.

 In the option market, you ONLY sell uncovered puts on stocks you’d want to own, and at prices at which you want to own them. 

When you sell an uncovered put, you collect a premium up front by agreeing to buy shares of stock at a certain price and on a certain date. The premium you receive from selling the option generates cash income right away. It also offsets some of your risk, in case the underlying stock moves lower.

You see, by receiving an upfront premium for selling uncovered puts, your potential loss is hedged by the premium you receive. For example, if you sold an uncovered put option and received an upfront cash premium of $3 per contract, you put $300 in your pocket for every contract you sell (each option contract covers 100 shares). That upfront cash premium makes up for a potential move to the downside.

Ideally, the stock will move higher. That makes the option premium move lower. When that happens, you can buy back the uncovered put options at a lower price – keeping the difference in cash profits.

But, if the underlying security moves lower and the put option premium goes higher, the premium you receive protects you from a certain amount of downside. So, selling uncovered put options provides a little cushion on the downside – making it possible for us to make money on the trade even if we’re wrong – while still giving us exposure to the upside of the trade.

If the stock falls so much that the put option contract is exercised on the expiration date, we’ll be assigned 100 shares of stock per contract sold, at the agreed-upon strike price – which we were willing to pay in the first place. That’s why we only sell uncovered put options on stocks we’d like to own, and at prices we’d be willing to pay.

Here’s an example of a trade we recently did in my subscription service Jeff Clark Trader…

In early-November, shares of Mosaic Inc. (MOS) were trading for $33.36 per share. The stock was cheap, trading at just five times earnings while competitors were trading for twice that valuation. The MOS December 15 $32.50 puts were trading for $1.45.

By selling this option, we collected $145 for agreeing to buy shares of Mosaic at $32.50 if the stock closed below that level on December 15. 

In other words, we got a $145 up-front payment for agreeing to buy MOS about 3% below where it was trading. And, where it was trading was at about half the valuation of other companies in the same business.

This really seemed like a low-risk trade.

17.54% Return in Eight Days… Over and Over Again

Eight days later, MOS was trading higher. And, the put options we sold for $1.45 were trading for $0.31.

We took advantage of that move and closed the position by buying back the put option. We recorded a $1.14 per share gain on the trade. That works out to a 17.54% return on the margin requirement for the position – in just eight days.

Think of it this way…

There was a stock trading for just five times earnings. It was cheap, and I wanted to buy it anyway. But, rather than buy the shares right away, I struck a deal to buy the shares at a 3% discount if the stock fell that far over the next few weeks.

For that obligation, I got a $145 up-front payment.

The stock didn’t fall. Instead it rallied. And, I was able to buy back my purchase obligation for $31 – thereby locking in a gain of $114 on a stock I never had to own.

Imagine doing that every eight days… whether the market is up, or down.

That’s what we’re doing at Jeff Clark Trader – turning the option market casino into a cash register.

If my college-aged son can learn to do it… so can you. Check out how I taught him – quickly and easily – right here.

Best regards and good trading,

Jeff Clark