(Ed Note: Selling puts is one of Michael Campbell’s favorite strategies. Dennis Gartman’s comments below)
It’s one of the most valuable and most actively traded assets on the planet.
It boasts great intraday trading ranges, with tons of liquidity, which makes it easy to enter and exit and very fair prices.
And with the stock market’s recent jump in volatility and sharp declines, it’s the asset of choice for many people seeking some shelter from the storm.
I am, of course, talking about gold.
And the question I’m going to address today is simply this: What’s the best way for you to invest in it?
Why You Need Gold in Your Portfolio
Since the stock market hit an 18-month high back in April, it’s trended lower. And on several days, we’ve seen all-out chaos and panic – for example, when the “flash crash” sent the Dow tumbling by 1,000 points in just a few minutes.
As the market has stumbled through the spring and summer, gold has moved higher, as investors hunt for protection from the volatility.
Gold should make up a part of your portfolio anyway, but with the market’s erratic behavior expected to continue, it’s even more important to have exposure to some gold.
One of the best ways to achieve that is by selling naked put options. Sounds sexy – and it is!
Buy Gold for $100
Now that we’ve decided to add gold to our portfolio, how about we decide the price at which we’d like to buy it? Not only that, how about we grab some instant cash from the deal, too?
Sounds like a no-brainer, right?
Even better… with gold having pulled back by about $60 per ounce over the past few days, this dip could represent an excellent time to buy.
Okay, so our first job is to decide what level we’re interested in buying gold. Then we just need to sell put options at the corresponding price (known as the “strike price”).
To make life easy, we’ll concentrate on the exchange-traded fund that tracks the price of gold futures contracts on the COMEX in New York – the SPDR Gold Trust (NYSE: GLD). One of the other benefits that GLD has is that it trades at about one-tenth the size of the underlying futures contract, making it viable for many smaller, everyday investors.
As an ETF, GLD, trades just like a regular stock on the NYSE. It’s currently trading for about $116.50 per share and when it comes to picking the price you want to pay for it, there are plenty of choices available.
For example, you could base it on the 200-day moving average line, which shows support at $110. That would be a nice $6.50 discount. But what if you want to go even lower and buy at $100 per share?
In this case, we could sell the December 2010 GLD $100 put options for about $2 per contract. Because there are 100 shares in each contract, we’d get an instant $200 for making the trade, based on selling one contract (100 shares). If you feel like buying 1,000 GLD shares, you could sell 10 option contracts, dumping a quick $2,000 into your account.
So what does that do for us?
Get Gold At the Price You Want… And Get Cash, Too
Simply put, it means we’re now obligated to buy GLD for $100 if it drops to that price by expiration in December. And for that obligation, we collect cash.
Sounds like free money, right? Well, it is – as long as you’re comfortable buying the corresponding number of GLD shares at your chosen level. So with GLD currently at $116.50, you’d be contracting yourself to buy it at $100 – a $16.50 per share discount.
What’s the catch? Not much, except that the price of GLD could drop lower than $100 per share after we’ve obligated ourselves to buy it at $100. But that’s the risk with any investment – the price can go lower.
However, if you’re comfortable buying GLD for $100 and know how to manage a stock position, then it could be worth your while to have someone give you instant money in return for having the chance to buy a stock at a much cheaper level than its current price.
Your Six-Step Put-Selling Checklist
Before you execute a put-sell trade like the one above, you need to be aware of a few important things…
- You’re selling put options as the initial transaction, not buying them.
- For the duration of the trade, your broker will ask you to keep a portion of the total cost for the shares available, in case you’re obligated to buy them. As such, your options trading account will need to have margin capabilities.
- Whatever strike price you sell put options for, that will be your maximum profit potential at first.
- In order to actually purchase the underlying shares at your chosen price, the stock must close below that level on expiration day. So in our GLD example, the stock must close below $100 per share on expiration day in order to receive your shares. And you must have the cash to pay for the shares in full at that time.
- If the stock you choose closes above your strike price level on expiration day, you don’t get to buy the shares. But you do keep the initial cash you received. At that point, the trade expires.
- Remember that whatever stock you choose can drop below the price at which you buy it, so make sure you have a risk management plan in place. In addition, you can always buy back the options you sold before expiration if you want to lock in a profit.
In terms of receiving passive income, selling put option contracts can be a great way to generate income throughout the year.
When you sell at levels significantly lower than the current price of your chosen stock, the chances are high that you won’t have to buy the stock. In fact, up to 90% of the time, the options simply expire. So while this means you won’t get to buy the stock at your desired price, you do get to keep the cash over and over again.
If you like the idea of pocketing cash in return for the chance to buy the stocks you want at the prices you want, I’ve got an entire trading service devoted exclusively to the strategy. It’s called The Instant Money Trader and in it, I’ll show you exactly what stocks and options to play so you can grab the maximum reward for the smallest risk.
And I’m proud to say that since I started the service back in November 2008, it’s notched up a win rate of over 90%. For more information on The Instant Money Trader, take a look at this report.
Good investing,
Lee Lowell – Investment U
Gartman: Gold Can Go Parabolic
(advance to the 2:20 mark for Gartman’s comments, For a Trial Subscription go to The Gartman Letter)
MONDAY, JUNE 28, 2010
Gartman: I don’t get the sense that the public is terribly involved.
CNBC anchor: Wait you don’t think the public is involved in the gold trade Dennis?
Gartman: No, not much at all actually
CNBC anchor: But the holdings for GLD are at record highs
Gartman: I understand but you look at who holds the ETF, it’s not the public. I’m impressed by the institutional demand that has gone to the ETF. I’m certain the public is there. But this is not one-sided. This is not panic. This is not the kind of frenzy that we had in the gold market in the early 1980’s. This is not the kind of panic frenzy that the public got involved in in tech stocks in the early part of this century…this is different.
Silence.
Lee Lowell, long with Karim, Lee is one of America’s leading options professionals. Over the course of a distinguished career, which includes six years in the options “trenches” as a market maker on the floor of the New York Mercantile Exchange (NYMEX), he has developed a proprietary trading method capable of enormous upside while actually reducing risk. Lee’s been actively trading since leaving the floor in 1998. He’s perhaps best known for bestselling book Get Rich With Options: Four Writing Strategies Straight From the Exchange Floor. Lee is also the Futures and Commodity Specialist for The White Cap Research Group.