There’s no doubt that many of our biggest shares are trading a little on the cheap side at the moment. Of course, there may be very good reasons for this, and you should always fully investigate why they may be on sale. Aviva shares are a great example.
But I think it’s reasonable to apportion at least some of the blame to the general Brexit-related funk that’s around.
And as an income investor, those low valuations mean one very important thing — sky high forecast dividend yields.
So, let’s say you want a slice of the action. Instead of just buying the shares at their current level, you could set a buy price below the current price and get paid whilst you waited to see if it triggered. Sound good?
The technique is called selling cash-secured puts and it’s the perfect complement to selling covered calls.
Selling puts on Aviva shares
Okay, let’s get the jargon out of the way.
A put is an options contract that allows the holder to sell a set number of shares, at a fixed price, within a certain period of time. (You can also watch my short video where I review the basic definition of Puts and Calls).
And selling a put means that we are going to sell a contract on shares that we would like to own. And we’ll get paid a premium for doing so.
Let’s have a look at an example (and just to be clear, this is definitely NOT a recommendation to trade).
Aviva Plc — with its 7.7% forecast dividend yield — is the sort of share that would look at home in any income-seekers portfolio. It’s currently changing hands for 415p per share and I’d be happy to pay that.
But what if I could pick the Aviva shares up for 400p each — that would be even better.
And if I could get paid 13p per share whilst I waited — that would be fantastic.
Welcome to the world of selling cash-secured puts.
Earning money to wait to buy Aviva shares
My online platform is currently showing that I can sell an Aviva 400p strike August put for 10p per share.
As with calls, a single put represents 1,000 shares.
So, I am committing to paying £4,000 for a thousand Aviva shares if the put option is exercised between now and 16th August. That’s 56 days away.
The buyer of the put will pay me £100 for my commitment. That is mine to keep whatever the outcome of the trade and represents an annualised yield of 16.3%. Not too shabby.
When you sell the put you are entering into a commitment that has two possible outcomes.
If the share price stays above 400p, the put expires worthless. You keep the £100 premium and you are free to sell another put with a strike price and expiration of your choosing.
That’s a pretty good source of income.
But what happens if the put is exercised?
If the Aviva share price drops below 400p, the owner of the put is likely to exercise it. That means that you will have an obligation to buy 1,000 Aviva shares for 400p each.
Is that a problem? Well it shouldn’t be. Remember that we analysed Aviva and decided that we would be happy to own the shares for the long-term.
We were also happy to pay 415p each for them.
So, if you now only have to pay 400p for them and you have collected a premium payment of 10p to boot, that’s a pretty good deal.
However, the eagle eyed amongst you may have spotted the ‘risk’ with this strategy.
The buyer of the put, has bought it for a reason. If the price of their shares drops below a certain level, they want to ensure that they can sell them at a fixed price.
As the seller of this ‘insurance’, you have committed to pay 400p per share regardless of the price they are trading for when the put is exercised.
That sounds scary!
Well, in theory it could be, but it’s actually less scary than simply buying the shares outright.
Let’s imagine you buy the Aviva shares at their current price of 415p and that they then drop to 390p over the next few months. You would be out of pocket by 25p per share. Not nice.
Now, let’s imagine that instead, you had sold the 400p strike put we have just described. After the drop to 390p, the owner of the put would certainly exercise it and you would have to buy the shares at 400p.
That’s a 10p difference. However, you will also earn 10p for the put and can offset your paper loss with that.
That means that you are just about flat (exc. stamp and commissions). That’s a whole lot better than the 25p loss if you had simply bought the shares outright.
So, as long as you actually want to own the shares, this is a great way to initiate a position and earn income whilst you wait.
Or better yet get in touch and we can have a chat.
Third Friday Ltd are not regulated by the Financial Conduct Authority and the FIRE Revolution training programme is purely educational in nature. Under no circumstances do we provide any financial trading or investment advice. Any examples used are for educational purposes only and should never be construed as advice. We accept no responsibility for any investment losses you may incur. Please consult a financial advisor or other qualified professional if you are in any doubt as to the suitability of the strategies we teach.