From Smart Investing Daily

I know, at first glance it seems either too good to be true, or possibly illegal, but there is an easy-to-use trading strategy which allows you to buy a stock for 10-20% less than its retail trading price. This strategy is especially useful when the stock markets are trading sideways as they have been for the past few weeks.

Unfortunately sideways markets can really drive investors crazy, not to mention cause some potential damage in our accounts. But just because the markets are moving sideways doesn’t mean you can’t make money. The truth is, although a sideways market can have a plethora of volatility, it can start and end up in the same place.

The good news is I have an excellent way to play this exact scenario. For the inaugural issue of Smart Investing Daily, I’m going to share with you one of the simplest ways to reduce risk, lower costs and decrease volatility in your account… with an options strategy – more specifically a Cash Secured Put.

Let me explain how this simple-to-use options trading strategy works.

Taking Advantage of the Peaks and Valleys in the Market

The earning season is just winding down and the last I checked the Dow Jones Industrial Average, S&P 500, and even the NASDAQ are trading pretty darn close to where they were the week of July 12, which is when the announcements commenced. Moving forward over the rest of the summer, I really don’t see much more upside catalyst in the broad market – at least not until the next earnings report or when we see a dramatic shift in economic indicators. But we will see some peaks and valleys plus/minus 4% from where we are now.

As a statistical and technical trader, I conduct a ton of analyzing and comparisons when it comes to stock behavior to find the most advantageous strategy. I also strike to remove as much risk as I can, while still maintaining an exceptional return.

Take the SPY for example, which is one of my favorite exchange-traded funds (ETF) that tracks the performance of the S&P 500 (at one-tenth the price). Let’s assume on June 14 you thought the earnings season was going to be strong and bought 100 shares of the SPY at $110.50. That trade would have cost you $11,050.

Just two weeks later, by July 1, the SPY drops to $101, which would equate to a $1,000 or almost 10% loss in your account. Don’t you wish you could have waited?

Timing a Cash Secured Put

Selling a (cash secured) put is one of my favorite strategies and if you are a stock trader just coming over to the world of options, it’s also a great “bridge” strategy, because it combines the best of both worlds.

Try to sell a put on a day when the stock market is selling off and you think there is a buying opportunity. I say this because the short put, which is bullish, will be more expensive when stocks are lower and allow you to take advantage of market volatility while giving you a statistical edge!

When you sell (to open) a put, you are obligated to buy 100 shares of a stock at a set price (the strike price). For that obligation, you are paid a certain amount called premium. You pick the strike price you want to sell, which would be the price you would want to buy the stock.

(Don’t let your eyes glaze over. I’ll make it simple. Options may require a little more homework, but once you understand the basics, you will have immense power at your fingertips.)

Now let’s flash back to July 14 when the SPY was $110.50.

Instead of buying 100 shares of stock, you could have chosen to sell 1 SPY August 105 put (105 is the strike price) for $3 each ($3 is the options’ premium).

In this example, you have obligated yourself to buy 100 shares of SPY for $105 on expiration (remember its trading for $110.50) and you got paid $3 to do the trade!

I know the word “obligated” is scary but that is where the “cash secured” part comes in. If you set aside money in your account (in this example you’d need to set aside $11,050), you have all the money you need to meet your obligation to buy the stock and you get to keep the $300 for which you sold the put! That $3 per option contract reduces your cost basis in the SPY to $102, which is a 7% discount to where it was trading.

The bottom line is that while the stock trader who bought the stock at $110.50 would have been sweating bullets when the index was dropping to $101, you felt a bit better in this case knowing that you only paid $102 total.

In some cases, you can collect 10-20% or more of the stock price when you sell a put with 30-40 days until expiration, which would be an annualized return of 100-160% on a trade with increased odds of success.

The one thing you have to remember about this trade is that even though you set aside cash for this trade, you may NEVER have to buy the stock at all; the put may just expire worthless. If this happens you would simply keep the cash that you received when you sold the put in the first place and do it again next month.

So When Does the Trade End?

Remember that all options are decaying assets and since you sold the put, you are hoping it decays to zero. If the put drops in value before expiration, you can always buy back the put and capture your profit!

When you sell a cash secured put, you want the stock to stay just above the strike that you sold. In our trade example, SPY at $105 or higher means that we keep the $3 per contract when the option expired in August. In the SPY with this strike our return would be roughly 36% annualized.

If SPY was below $105 on August expiration, we could always choose to take delivery of the stock at $105, still keep our $3 per contract, and be in a better position than our stock trading brethren since our cost basis in the stock was $102.

If the S&P 500 just explodes to the upside, one of the disadvantages of the short put is that we have limited upside to the money (premium) we collect at the onset of the trade. That is why I prefer a strategy like this in sideways markets.

And there is a multitude of opportunities out there. We just need to uncover them and exploit them in the right way.

If you’d like to learn more about trading options successfully, my friend and colleague Adam Lass has put together an options trading tutorial. In the four-part instructional video series he goes over the basics of options trading and how to make them work for you. You can view the options trading course here.

And I’ll keep you posted when I see opportunity, whether it’s a strong put candidate… the best ETF out there… or the hot penny stock that you should consider for your portfolio.

But one thing’s for sure: there will be much more market-maker insight to come… so keep reading!

Get to Know Jared Levy

Jared Levy has a passion for teaching the public how to successfully and consistently invest, while keeping risk low. Now as co-editor of Smart Investing Daily, he can help you do that too. Learn more about Jared here.

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