By Steve Papale
Happy Cinco de Mayo! Cinco de Mayo is not Mexican Independence Day. In fact this holiday commemorates the Mexican army victory of the Battle of Puebla in 1862. The Mexican independence day is September 16 FYI. This battle occurred during Mexico’s war with France. In fact this holiday is bigger in the US than it is in Mexico. So take the rest of the day off – its Cinco de Mayo!
I watched a video the other day sent to me by an investment newsletter. They claimed to have a secret way to make money that only the most sophisticated institutional investors know about including Goldman Sachs and Warren Buffett. They claimed anyone can do it so they went to random people in the street with a laptop and had them perform the transaction. They then paid the participant half of whatever cash the transaction generated, a few hundred dollars in a few minutes. Pretty easy money.
What the secret strategy? Put selling.
Most of our readers are familiar with the strategy. Sell a put and collect the premium. It is a great strategy – probably on a risk adjusted effort weighted measure the best I have ever used. But it’s not exactly free money the way the video portrayed it. As we know, the seller of an option has an obligation. In the case of selling puts the obligation is to purchase the underlying at a fixed price over a fixed time upon demand from the put buyer. If the buyer makes no demand (does not exercise) then the seller keeps the money and has no further action.
However if the buyer exercises then the seller must buy the underlying at the strike price. So if I have an obligation to buy at $100 and the underlying is at $80 suddenly that few hundred dollars I collected don’t seem much consolation. The video didn’t get into any of that – just the happy person pocketing a couple hundred dollars for taping on a couple computer keys for a few minutes. Don’t get me wrong – like I said before this is by far and away my favorite options strategy month in and month out. We sell both puts and calls on a particular type of stock that keeps our risk down and gives us a little extra yield on top of our option premium. You can and likely will do very well implementing it. But proper implementation of it, like all trading or investment strategies require thought and preparation.