With the market seemingly making new all-time highs week after week, I don't have to tell you that the available "discounts" on quality companies are few and far between.
So, I'd like to dust off one of our favorite strategies for dealing with a pullback: getting paid to buy stocks at a discount. This is the strategy that one of our experts, Amber Hestla, has been successfully using in her premium newsletter, Income Trader .
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For those who are unfamiliar, you can in effect get paid for the chance to buy stocks at a discount by utilizing a conservative strategy that involves selling put options contracts.
Here's how it works...
Let's say you really want to buy Netflix (Nasdaq: NFLX ). But at a recent price of just under $132 per share, you feel like shares are a little expensive. At that price, the stock is trading about 3.5% above analysts' 1-year target.
You'd feel a lot more comfortable about buying if it were trading for less -- say, $125, which is 5.3% below the recent price. At that level, sure, the stock would still be a little rich, but you could live with it. After all, we're talking about Netflix. It's a good company and it's not going anywhere.
Now, you could place a limit order to buy NFLX at $125 a share. After all, it's not unthinkable to see a pullback in the market or some other event that causes shares to drop to your preferred buy price within the next few weeks or so.
Then again, maybe it won't.
Perhaps you'll find some place to park your cash in the meantime and earn a little bit of interest while you wait. Then again, in today's low-interest rate environment, that's unlikely.
Forget that. Do yourself a favor and don't allow either of those options to back you into a corner. If you really feel that uncomfortable with Netflix's current price, then I'm here to tell you that you have a third choice: selling put options.
Put options give the owner the right -- but not the obligation -- to sell a stock at a specified price before a specified date. When you sell a put, you are obligated to purchase that stock from the put buyer if shares fall to the specified price (the option's "strike price")
Using the example above, you could sell a put option on Netflix with a "strike price" of $125 that expires on March 17 for a "premium" of around $5.85.
The premium, or what Amber calls "instant income," is what you receive from selling the option -- in this case, about $585 per contract. (An option contract controls 100 shares, so $5.85 x 100 = $585.) And it's yours to keep no matter what.
If NFLX is below $125 per share at expiration, you will be required to buy shares for that price. But remember, that's the discounted price you wanted to pay for NFLX in the first place. And because you already pocketed a premium for selling the put, your cost basis is actually $119.15 ($125 strike price - $5.85 premium).
That means if NFLX falls to $125 or below by March 17, you'll scoop up shares at a more than 9.7% discount to the current price.
And if NFLX doesn't fall to the strike price before March 17, you are no longer obligated to purchase the stock, but you keep the $585 premium.
What's great about this strategy is that you get paid to set the terms. You decide what you'd be comfortable paying for a stock should it fall to the specified price. And you set the timeframe that you're willing to wait. It lowers your cost basis if the stock falls to your strike price, and if it doesn't, then you simply keep the premium as pure profit.
What's more, you can repeat this process again and again -- and scale it up depending on your comfort level.
As we've said before, selling puts is about as close as it gets to a win-win in investing. In fact, since Amber launched Income Trader in 2013, she's managed to post an astonishing 134 winning trades out of 140. That's a win rate of 96%.
If you're not familiar with options, but this sounds intriguing to you, then we have a special presentation that goes into more detail about Amber's strategy. And if you choose give Income Trader a risk-free trial, you'll also get a full slate of reports to quickly get you up to speed on options trading . To get started, go here now .
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
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