Like the article? [Upvote on Reddit] [Upvote on Hacker News] [ Follow me on Twitter ]

You're smart, but you were never successful in the Stock Market...
At times, your portfolio may have been up significantly, but eventually your performance would settle down to just mediocre. It was just too difficult to beat the averages. So after a while, you brushed the Stock Market off as something for chain-smoking wall street guys. You'll stick to your quest to build the next YouTube. (which by the way, if you can build me a guide for that one, let me know).

How often are you succesful with your stock trades? Chances are, you are probably profitable on about half your stock picks. What if I told you there was a strategy that is profitable 90 or 95% of the time? There does exist such a strategy, and lots of smart people like yourself use it every day to make lots of money. It's called Selling Naked Puts (with a name like that, how could it fail?). This article will give you the basics of how to put this strategy to good use.

First, some background on stock options:
"Puts" are stock options contracts. If you BUY a Put on a particular stock, you are purchasing the right to sell that stock at the Put's strike price. Every option contract also has an expiration date. For example, if Apple stock is trading at $100 on October 1 and you buy a Put with a strike at $95 and an expiration of Oct 16th, if the stock dips below $95 before Oct 16th, you can still sell Apple at $95. Buying a put is like buying an insurance policy on a stock. It limits your downside.

Conversely, if you SELL a Put, you're taking on the obligation to buy the stock at the Put's strike price. When you sell a put, someone pays you at time 0 for that Put..(perhaps a couple hundred dollars). In the example above, if you sold the Apple $95 Put, if Apple went to $90 you'd still be on the hook to buy it at $95 for a $5/share loss. However, if Apple remained above $95, then you'd simply profit from the sale of the original Put contract. You'd have no obligation to do anything to cover your position. The Put would simply expire, and you'd keep your proceeds.  When you sell a put, you're effectively selling an insurance policy. The policy holder (buyer of the Put) pays you to take her downside risk away. If the downside event doesn't occur, you profit. And if it does, you have to buy Apple stock.

The magic of selling Puts on stocks you actually want to buy:
What if you don't mind owning Apple stock? What if you were going to buy Apple stock at $100 anyway? If that's the case, then your worst case situation of selling a Put on Apple isn't that bad. Even if you're forced to buy Apple at $95 when it's currently trading at $90, at least you own a stock you want to own. And besides, if you were going to buy the stock at $100, you'd still be down if it was now trading at $90. My point is, selling Puts is an excellent strategy when you sell a Put on a stock you don't mind owning. Your worst case scenario just isn't that bad. And your best case scenario can be highly likely.

How likely is your best case scenario? In the beginning of this article, I mentioned you can profit in 90% - 95% of the Puts you sell.  The truth is, you can ultimately choose how sure you want to be about landing in your best case scenario. The higher the certainty that your trade will be a success, the lower the proceeds you will collect when selling the put. And vice versa. You can use a stock probability calculator, to determine the degree of confidence in your trades. For example, the screenshot below shows you that there is only a 9.01% chance that Vistaprint (VPRT) will close lower than $45 on November 16th. (It's currently trading at $49).

This means if you were to sell a VPRT $45 Put today, you'd have a ~91% chance of keeping those proceed from selling the put, without ever the need to buy VPRT stock. According to Yahoo Finance, the $45 Put sells for about&m=2009-11"> $205 per option contract. If you want more than $205 per contract, simply sell a put with a higher strike (and therefore a higher probability VistaPrint will actually close below that strike price). You could also choose to sell a Put contract with a longer expiration (perhaps expires in December). Because there's more time for the stock to reach it's price, you are compensated for this additional risk.

There is a magic to small gains. If you consistently place these smart bets, you'll be surprised how quickly they add up. Although you may only make $205 per contract, if you buy multiple contracts and consistently win the bets, you'll grow your portfolio quickly.

Of course, the strategy is not risk free. If the stock for which you sell Puts crashes, you're legally obligated to purchase the shares at the MUCH higher strike price. But remember, if you were going to buy the stock anyway, you are no worse off with this strategy. Except that with this strategy, you'll win 90% of the time.

Appendix:

*** Please don't sue me. I don't promise you'll profit from this strategy. I'm merely relaying a strategy that's worked very well for me over the last 4 years. You should be well versed in the details of trading Stock Options before you do so, as trading options can carry significant risk (especially if you don't understand them). There are lots of articles on the web. Read up!

*** Make sure your brokerage account allows you to sell stock options
I recommend Interactive Brokers for stock and option trading. It's used by the pros, and gives you real time access without the sugar coating. It's also cheap to trade. Only $1.50 or so per option contract. But feel free to use your ScottTrade, OptionsXpress, or eTrade account as well. You'll just need to sign a few pieces of additional paperwork.

*** Each option contract deals in lots of 100 shares of underlying stock. So buying 100 shares of Apple at $175 would cost $17,500. Not up to front that cash? Then try the strategy on a lower priced stock, where you can more easily afford buying 100 shares if the worst case scenario comes true.