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Last month, this article suggested the sale of two puts as an approach to generate income. That article further describes why the risks of these two trades was somewhat limited because the strike price was below the stock's book value, and why these trades seemed less risky than buying dividend paying stocks to generate income.

Last Friday, the $7 Sept. put on Bank of America (BAC) expired worthless yielding about 4% in a few weeks. Monday morning, the $13 Oct. Corning (GLW) put was trading around $0.52. That trade is in the money, but there is still a 4% premium on the table, this trade remains active for me and still could be entered into by a reader.

With option volatility still relatively high, it seems appropriate to continue with this strategy. Two more, short-term potential short-term put sales are listed below.

Bank of America (BAC) $6 October puts - As discussed in last months article, being put BAC stock at price of less than $7 means an investor will be buying shares at a better price than Warren Buffet got as part of his investment in BAC. Therefore, it seems reasonable that an investor could put on essentially the same trade as last month, selling $7 Oct puts.

Monday morning the stock was trading just under $7 and those puts were selling for $0.58. That means there is a potential for over an 8% monthly return if the stock remains flat for a month. However, an investor in BAC must be aware that in the current environment, almost anything can happen to this stock, and be comfortable being put the stock.

To provide more of a margin of safety, an investor could alternatively sell the $6 Oct puts for about $0.24 or a 4% monthly gain. While the returns are less than half as much as the $7 puts, this is still a significant amount of income as compared to today's fixed income returns. The stock would have to fall to $5.76 before an investor looses money.

That is another 13% down from here, well below the recent 52 week low, and well below the "Buffet Value". That margin of safety vs a 4% return seems like a reasonable risk/reward to take.

Alpha Natural Resources, Inc. (ANR) $26 October puts - ANR is a coal miner that recently acquired Massey (MEE). Last quarter's earnings were a disappointment to the street and the stock plunged down to $26. Yahoo finance lists ANR book value at $37. However ANR does have over $3 billion in goodwill and intangibles on the books which might be inflating that number.

Yahoo finance shows ANR with $5.8 billion in net tangible assets and 226 million shares outstanding. That results in an "adjusted tangible book value" of about $26, which perhaps not coincidentally matches the recent low in the stock price. Earning estimates are near $3 so the stock is trading with a P/E of under $10. Hopefully the stock will hold $26 over the next month.

Given the past issues with this stock the option volatility is very high. Monday morning the stock moved down toward $28 potentially on some coal industry downgrades. The Oct $26 puts were selling for $1.35. An investor would either

  • Generate 5% in income on cash secured puts in one month if the stock does not fall about 8% in the next month.
  • Be put the stock at an effective price of $24.65. That is 12% below the current price.

That seems to represent a reasonable risk/reward and certainly provides a portfolio a position that will perform somewhat differently than the typical stock in this highly correlated market.

Some investors might be more inclined to buy the stocks and write calls against them. This is often touted as a less risky approach to generating income. However, given the higher volatility of the puts than the call (skew) selling puts is actually more rewarding and requires a little less capital commitment.

Source: Generating Income: 2 Put Selling Opportunities