Stock options can generate extra income. Here's how.

  • By Steven M. Sears,
  • Barron's
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The thirst for yield in a world awash in low interest rates is leading investors to the options market—and that’s a great place to be.

They are increasingly embracing the cash-secured put sale strategy to create returns that generally far exceed what is available in the bond market. To create returns that can exceed 3% on their cash, these investors are increasingly selling puts on blue-chip stocks that pay dividends to create and enhance returns.

This is one of the simplest options strategies in existence. Investors simply identify stocks that pay dividends and then sell puts with strike prices below the stock’s price and with expiration dates usually of three months or less.

If the stock advances, investors keep the put premium, which often represents a return of more than 3% on idle cash. Should the stock price be below the put strike price at expiration, investors usually buy the stock (rather than cover the put) and allow themselves to be “put” a blue-chip dividend stock.

We have long advocated this strategy, and now it seems to have been embraced by major institutional investors, suggesting the strategy is poised to enter a golden age as investors confront negative interest rates, and extraordinary low rates.

In recent sessions, when the stock market seemed poised to suffer acute declines due to the pending impeachment proceedings against President Donald Trump, the cash-secured put sale strategy exploded in popularity. Rather than selling stocks, or even buying defensive puts to protect stocks, which is what one would normally expect during a sharp decline, some investors sold puts, often in very large sizes.

Among the key trades:

  • In Procter & Gamble (PG), an investor sold 7,000 October $118 puts at 45 cents.
  • In Clorox (CX), an investor sold 5,000 October $70 puts for at prices down to 29 cents.
  • In BorgWarner (BWA), Investors sold 3,000 December $27.5 puts at 47 cents.
  • In Kraft Heinz (KHC), investors sold 2,500 October $26.50 puts at 20 cents.
  • In Ford Motor (F) investors sold 40,000 November $8 puts at $2.95.
  • In McDonald’s (MCD), investors sold 20,000 January $190 puts at $2.75.
  • In Walmart (WMT), investors sold 15,000 October $38 puts at 31 cents.
  • In Symantec (SYMC), investors sold 10,000 October $23 puts at 35 cents.

The size of the put sales was extraordinarily unusual.

Major investors—and that is the only type of investor who could afford to trade puts that represent tens of thousands of shares of stock—often just focus on buying stocks. They rarely sell large amounts of puts as a way to control equities. This reflects a historical mistrust of options, concerns about options liquidity, and a broad stock-centric bias that exists in the institutional money management industry. Those biases, however, have been eroding in recent years and they now seem poised fade as all investors are now increasingly confronting a world in which it is hard to generate meaningful investment yields without taking on significant risks.

The big put sale trades, which Chris Jacobsosn, a Susquehanna Financial Group strategist notified his clients about, should thus be viewed as a sign that the humble cash-secured put strategy is no longer a secret of well-heeled individual investors with the resources and smarts to determine their own outcomes.

Now, it seems the strategy is poised to grow in use and importance at a time of extraordinary singularity in the markets, economy and Washington.

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