PPT eletter 11/25/22
SL: Income Generating Strategy to Offset Inflation
By Tom Gentile
I didn’t want to ruin your Thanksgiving dinner appetite, so I waited until after to show you how much more you paid for your Thanksgiving meal this year.
The latest Consumer Price Index (CPI) reading came in at 7.7%, and the media was touting “the smallest year-over-year inflation increase for the food index,” which would be great news except that the index increased 12.4% from a year ago.
The overall food index is higher year-over-year, but here’s what has happened to Thanksgiving dinners since last year’s holiday:
- Turkey’s – up 21%
- Stuffing – up 69%
- Other Ingredients – up 20%
As you look at the graph below it’s clear we have quite a way to go, which can take months, and possibly years to achieve.
When inflation runs significantly higher without adequate income increases, it only reduces your buying power – your dollars won’t get you as much as they used to.
Let me tell you about a strategy that can be used to offset inflation.
The strategy involves selling puts on stocks you do not own, but wouldn’t mind owning in the future, and which means getting a credit in your account immediately.
And, over the past three years, my win/loss ratio speaks highly of the strategy:
- 2020 – 100%
- 2021 – 94%
- 2022 – over 90%… so far
By comparison, the S&P 500 fluctuated between 30% downturns to 27% gains throughout these same years.
This means this income generating strategy works well in a wide variety of market conditions.
Let me tell you about it…
Selling Put Options for Income
The first thing to know is that by selling put options you’ll be under an obligation to buy stock at a specific price (strike), at a specific date (expiration).
To get a little more comfortable with what that means, let’s break down the parts of a put contract so you’ll get an idea of the terminology.
In the illustration below you’ll see that we sold 1 option contract. Its expiration is December 23, 2022 and the strike price is $40 – which is the amount we’ll pay to buy the stock in the future if we want to. The credit our account will receive from selling this put is $128.
Now, since we hold an obligation to buy shares when selling puts, it’s possible that we could be “assigned” shares of the stock before expiration, but that’s the exception, not the rule.
This simply means we should only sell puts on stocks we are willing to invest in.
Potential Outcomes of Selling Puts for Income
There are two potential outcomes when selling puts for income, and it depends on where the stock lands when the option expires – the stock’s price will be either above or below your strike price.
For the first scenario, let’s assume the stock’s price closes below the $40 strike price at its expiration. If this happens, the option is considered to be “In-The-Money,” which essentially means the contract will be exercised – and we will own shares unless we buy back the option before expiration to be released from the obligation.
If assigned, we’ll end up with 100 shares of the stock for each contract and we’ll pay $40 per share for the stock. However, we’ll also keep the $128 of income we received when we first sold the contract.
Another scenario is possible as well – the stock may close above our strike price, in which case the option would expire worthless.
In this second scenario we’ll have earned our $128 income and we’re now ready to move on by selling another option for another credit – thus, creating a regular stream of income for our account.
The vast majority of these income trades have resulted in receiving income to the portfolio.
As one of the easiest option strategies to learn and employ, selling puts is a great way to help offset the high cost of inflation.
Until next time,
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