I often recommend selling put options that extend out as far as January 2017. Many traders, however, seem hesitant committing to option trades of that length. Today's nice jump in Yum! Brands (YUM) shows why using long-term expirations is often the best choice.
You will always take in greater absolute dollars by selling more time, not less. When a nice upward move occurs, there are larger potential gains to be locked in.
Last Dec. 10, I took advantage of YUM's selloff to around $70 to write some YUM January 2017 $60 and $65 strike price puts. Those were pretty conservative puts, as they were out of the money even after YUM's drop. The option premiums of $5.15 and $7 per share lowered break-even points even further.
I was able to close on Friday morning for a fraction of the original selling prices even though there were still more than 17 months until expiration. That captured 60.2% of maximum potential profit less than five months from the trade inception date.
Here is the final math on the completed transactions. The net profit was $2,788 out of the $4,632 that was collected up front upon sale of the options.
The two sets of puts were sold in a margin-type account, using paid-up equity as "buying power." My original net out-of-pocket cost was a negative number. The BTC cost was a fraction of what I took in to start. That makes my return on investment infinite, as I never actually laid out any net cash.
Trades like these are not the cornerstones of a portfolio. The meat and potatoes of any good plan is outright ownership of shares. Put sales merely serve to goose returns by adding incremental dollars to your end-of-year profit picture.
Portfolio sizes that allow for a diversified number of put sales often let you find tens of thousands, to even hundreds of thousands, of extra income over the course of a year. That makes more of a difference under ZIRP conditions than ever before.
The ability of your existing stock holdings to support option writing activities (both covered calls and naked puts) is a huge untapped resource that most investors allow to go fallow.
My worst-case scenario, if the puts had eventually been exercised, was the forced purchase of YUM at net prices of $54.85 or $58. Those seem laughably low with YUM now hovering north of $90.
Why did I pay to close when I would be happy to own at those prices? The most I could have gained from waiting another 631 days was about 3.25% on the $60 strike price and just 4.07% on the $65s.
I'd rather use the freed-up buying power for new trades offering larger potential gains.
At the time of publication, Price had no positions in the stocks mentioned.