Watch stocks you care about
The single, easiest way to keep track of all the stocks that matter...
Your own personalized stock watchlist!
It's a 100% FREE Motley Fool service...
The new year is the traditional time to make resolutions on things we'd like to do better. And unless you're one of Warren Buffett's superinvestors who have already mastered the stock market, you may find that you have room for a resolution or two for improving your investment strategy.
Unfortunately, resolutions are notoriously hard to keep. If they weren't, we'd all be rich, thin, nonsmoking marathon racers. But what if there were a way to get paid to keep your resolutions? Wouldn't that help motivate you, at least a little bit?
Fortunately, there often are ways to get paid from your investments, regardless of whether you're resolving to improve your ability to buy, to sell, to hold, or to sock away more. This is the third article in a short series on how to do just that, and it focuses on how to get paid to buy stocks.
Lessons from real estate
You may have heard the old rental real estate saying that "you make your money when you buy." That's absolutely true. With a lower buying price, any rent you collect will give you a higher return on your investment, and when it comes time to sell, profits will be more likely to result, as well. In owning stocks, the concept is similar, only rather than collecting rents, you may instead be collecting dividends.
Of course, it can be frustrating to wait for what Buffett has called a "fat pitch" before buying at a clear low price, especially when the market is rising. But the good news is you can get paid to wait for a stock you wanted to buy to reach a low enough price to be worth buying, through the process of selling put options on those shares, at a strike price where you'd be willing to buy the stock.
What you need
To sell put options, you need:
- Sufficient options privileges at your broker.
- Either a margin account or your broker's permission to sell cash secured puts.
- Enough cash or margin power in that account to buy at least 100 shares of the stock at the strike price.
It's also important to have a strong understanding of what the company you're considering buying is really worth. Because when you sell that put option, you take on the obligation to buy those shares at the strike price if the person on the other side decides to put the shares to you.
What to look for
That said, the ideal type of company to consider selling puts on is one that's a fundamentally solid business whose shares have been punished by Wall Street. What you're looking for is the chance to buy at a discount, but to be satisfied with collecting just the put premium if the shares never fall below your strike price. Potentially decent current put candidates include:
- Hewlett-Packard (NYSE: HPQ ) : This technology giant is going through some tough times, but nobody is expecting it to vanish completely. With its shares trading for around six times its anticipated earnings, a further collapse would be a huge surprise. Still, it'll likely take years for it to work through its current product confusion, making the stock also unlikely to run away quickly.
- Jones Lang Lasalle (NYSE: JLL ) : This office property management company has seen about 40% of its market value evaporate over the past several months, but it's actually expecting a decent future as real estate activity perks up. At around 11 times forward earnings, it's not an incredible bargain, but the March near-the-money puts provide an attractive offering of either cash in your pocket or a worthwhile price of the shares.
- Hospira (NYSE: HSP ) : This medical device company saw its shares tank a few months back when it got dinged by the FDA for quality control problems at a key North Carolina plant. Still, even incorporating the estimated $300 million to $375 million it expects to spend on remediation, it's trading at a reasonable 12 times expected earnings. With so much focus on improving its quality control, another near-term crash from similar reasons would be unlikely. Still, the May near-the-money put options are offering a decent premium from people wanting to buy insurance against another fall.
Beware the siren song
Of course, stocks can drop precipitously -- or even go down to $0 in a bankruptcy -- but anyone who has a written put open would still be on the hook to buy the shares at the strike price. So when you're considering selling puts, make sure you're willing to buy the related stock at the put's strike price, because that's exactly what you're contracting to do.
If the business isn't worth owning, it's not worth selling the put. For instance, Sears Holdings' (Nasdaq: SHLD ) shares collapsed last week. People who had been writing put options because the premiums looked attractive prior to the fall found themselves with an expensive obligation. Yet Sears isn't exactly a strong business -- indeed, it has been hemorrhaging cash recently. Also, its strategy of selling off unproductive stores is tough to execute in an environment with a glut of retail space available.
Likewise, if an industry is perpetually troubled, such as the airlines, even the leaders may not be worth buying at any price. Delta Air Lines (NYSE: DAL ) may be among the world's biggest airlines, and its puts may look attractive to sell on the surface, but bankruptcy has been an all too common end point in that business.
Still, if your investing resolutions include a desire to do a better job of buying low, selling put options is a great way to get paid to enforce that discipline. If you're of the mindset that you make your money when you buy, it's certainly a great way to keep your net purchase price down.