So, let’s say that we have done our research and decided that ABC Plc — a major supermarket — would be an excellent addition to our portfolio. The shares are trading at a fair price, have good fundamentals, and the chart looks good. It’s the sort of stock we’d be happy to own long term.
And, once we own it, we may also decide that we would like to sell covered calls against it.
It’s currently trading at a price that we are happy to pay, so we could march straight on in and buy a thousand shares. Perfect. Job done.
There is absolutely nothing wrong with doing that. You could then sit back and watch the dividends and covered call premium roll in.
Or, for no extra work, we could sell a put on ABC Plc instead.
We would be paid a premium for selling the put and we can select the price we wish to pay for the stock and the length of time we would like to honour the commitment for.
That’s the strike price and expiration date respectively.
With the shares currently trading at 250p, they have an impressive dividend yield of 4.5%.
ABC Plc is certainly a stock I’d be happy to own for the long term. Question is, how much would I be willing to pay?
Well, as we said, it looks pretty well priced at 250p. With the corresponding dividend yield I’d be happy to pay that.
Or, even better, what if we could pick it up for 240p — that would be even better.
And if we could get paid 5p a share whilst we waited — that would be fantastic.
Welcome to the world of cash-secured puts.