Those of you that are following Warren Buffett’s strategies want to invest in the stock market. You probably know and understand that he likes to buy companies and hold for life or for a very long time.
Then normally gets money through dividends or stock appreciation.
Those are the main things.
A lot of people talk about this strategy in this concept — earning the money.
But they don’t necessarily talk so much about:
- How do you acquire the companies?
- How do you acquire the shares?
- How do you do it properly?
Of course, you could just go out and just buy it and not worry about it.
I’m gonna show you a smart approach to getting it at a lower price and getting paid to wait by using options.
For example, you want to buy a certain stock — McDonald’s.
Let’s say it’s trading at $185/share.
Now you’ve got a 100 shares or 10,000 shares at that $185 price tag. This may all sounds fine and accumulate some dividends with time.
You could go ahead and look for that same stock and sell options against it and get paid to wait. You can get this stock at a lower price — let’s say at $165 because maybe the stock price is a little high and keeps heading higher.
You don’t know when a good pullback is and you’re trying to wait to get it at a lower value.
Here’s the way that this strategy works:
1. You get paid to wait.
2. If the stock stands still or it goes up then you can collect your money. You get your premium and you can continue doing this strategy month after month (30 to 60 days) and just keep doing it until that stock eventually will pull back.
3. When it does pull back and hits your strike price you’ll get assigned the shares. You need to have enough money in your account to buy those shares.
The strategy is called a Cash Secured Put.
Cash Secured Put
You’re gonna be selling cash secured put and you got to have enough cash to be able to cover that. Ultimately, you need at least a 100 shares of a certain stock to be able to buy it at that price.
So if you’re dealing with something like let’s say $5/share, well you need to be able to have $500. If the stock is $50/share that you sell the strike, you need $5,000. Makes sense? Because you need it times a hundred.
So that’s really what’s going on when you do this strategy.
We’re gonna take a look at Starbucks and the current price of Starbucks is $63 per share.
If I want to purchase this stock, we’re gonna look at $63 per share times 100 — that’ll give us $6,300. We need to be able to have enough cash to cover this amount.
So in order to purchase the stock at a lower price, how do I get paid to wait? The way that you do this is you sell cash secured puts against this.
So that would be at the 50 dollar mark and you can choose what price you’re interested in getting them.
Let’s say we go out to the 52 days.
I have my puts on the right side, I have my calls on the left side.
You can see all the different premiums and the current price is around $63 dollars/share. You could sell the 60s — that would be your strike price, you could get $5.05 for it multiply that by 100 so you get 505 dollars.
Which means you’re controlling or selling 100 shares.
You could go out to the 55 or the 50s on the strike prices and the further out you go the less that you make. Of course, as you go further this way you make less.
But you have a higher probability at this level if you get closer to the current price. You basically make more but it’s less chance of success.
It’s just a question of where you want to get to and your probabilities and chance of success is noted right here — based on the probabilities that are already outlined.
Take for example this one at level 45, it’s a 22% chance of success if you’re a buyer.
If you’re a net seller, just do the inverse of that or subtract a hundred and you get about an 80% chance of success. So here we’ll sell the single and that means I would need enough cash to cover this stock.
Since we’re doing it at $45 per share, so you would be paying $4,500 once you get assigned.
You can make $1.65, based on the premium.
If you multiply by a hundred, this gives me a $165 on the trade grid.
Taking a look at this risk profile, you can see:
- If the stock stands still, you make money.
- If the stock goes up, you make money.
- If it pulls back a little bit, you can still make that $165.
But once it hits under $45, you will get assigned.
You’re gonna have and see 100 shares of that stock inside your account and they’ll deduct that $4,500 from you Every single day you make $4.66 which is the theta here.
With time, the white line will get closer and closer to your green line and at expiration, you just collect the premium. You don’t have to do anything — you can just let it expire.
Now if it goes against you, you don’t want to get the shares assigned. Get out of it early, you don’t have to stay in the trade.
But if you do it too soon, like let’s say it just happens in the next few days, you could be out with a loss. Those option contracts are worth much more to the buyer.
Anyways, this is the way you could do it.
You can do this on many stocks and just remember that one single contract controls 100 shares. So you’ll be assigned 100 shares.
But if the stock continues to head higher, you could do this time and time again, month after month and collect your premium. The same example here on McDonald’s.
Let’s say the current price is $157.
If I want to go ahead and sell the $125, I could do that. This is 52 days out and I could do something like this.
In this case, I would make $4.25 on the McDonald’s — that means $420 as that continues to head higher. Take a look at the McDonald’s chart, you can see right now the current price is $157.
If I sold the $125, that gives me quite a bit of room — approximately, 30 points from where it is now. Basically, what you’re doing here is waiting and getting paid to wait for that stock to come back to you.
You would do this if the stock price is really high or maybe let’s say it’s sold off quite a bit and you’re not sure it’s gonna go lower. So it allows you to get further and wider.
The key thing here to remember is that you have to make sure you have enough cash in your account that once you get assigned. It could happen the 1st, 3rd or even the 10th month you do this.
Eventually, you’ll probably get assigned if you do this long enough unless you get out of it earlier before you get assigned.
At that point usually you get a little bit of a hit or loss if there’s not enough time decay that worked in your favor. In either case, this is the strategy it’s called a cash secured put.
You’re selling a cash secured put and you have to have enough money and cash in your account to be able to cover that good to do as you start to accumulate more and more shares. You could also reduce your margin requirements by buying protection further out.
So if I go ahead and buy a single one just a little bit further, I reduce that risk and exposure. But this is beyond the scope of this topic. So just something to think about as you look to selling vertical spreads.
