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is one of the more popular income generating strategies used by options-savvy investors. Generally, the strategy involves selling an Out of the Money (OTM) put on a stock on which you are bullish. This means the price of the underlying stock is higher than the strike price of the put option. The option may be 5-10% OTM at the time it is written. A put writer, who is find diabecon online, expects the option to expire worthless at expiration. And that's exactly what will happen as long as the stock does not drop in value below the strike price of the option. In this case, an investor keeps the premium received for writing the put, without ever owning the stock. The amount the option is OTM provides downside protection. If the option is 10% OTM, the price of the underlying stock can fall 10% and the premium can be kept and full profit realized. As an example: stock is $82. 03 Feb 75P is $. 40 due to expire 2/18/06 % OTM is 8. 6% (the stock can fall this amount before a loss is incurred) stock is $74. 65 () Feb 70P is $. 90 due to expire 2/18/06 % OTM is 6. 2% (the stock can fall this amount before a loss in incurred) In the first case, the $. 40 put premium will decline to zero as long as the price of IBM stays under $75 per share by February 18th. Therefore, IBM can decline 8. 6% and the investor will still be able to keep the premium and realize a . 4% profit in 50 days. The twist comes from an investor who took a different approach to naked puts. He forced assignment of the put (the obligation to acquire the stock), then being in position to collect the dividend from the stock. Once the stock is acquired, a is written against the stock owned. This methodology creates three different sources of income: 1. Naked put premium 2. Dividend income on the stock 3. Covered call premium If the timing on entering these positions is done carefully, all three forms of income can be acquired in a month or two, greatly increasing an investor's . To increase the probability of a naked put being assigned, it should almost always be written In the Money (ITM) or At the Money (ATM) as opposed to OTM. By writing the put ITM, the probability of assignment of the stock and your ability to collect the dividend is enhanced. Using this method, you would write the put with an expiration and assignment just before the dividend is declared. By writing the put ITM, there is an interesting play if the stock were to rise considerably. Since the option was ITM, the premium was very high. If the stock were to rise above the strike price the premium would drop considerably and, possibly, expire worthless. The downside of this scenario is that the stock is not assigned and, therefore, the dividend is not available. However, since the premium was so large for the ITM put, the overall return will be very high, and generally higher than if all of the income was acquired as originally planned. This is one case where writing options does not limit severely the upside potential of the stock. As an example: Assume Altria Group at $74. 65 (MO) 06 Feb 75 Put @ 2. 35 ITM . 5% If the stock moves over $75, the option price will drift toward zero and eventually expire worthless. This will happen in 48 days since the Feb expiration date is on 2/18. The return on just the naked put would be: Return = 2. 35 / 75 = 3. 13% in 46 days or 25% annualized Putting it all together with an example using the Altria as the stock: Data for the example with Altria Group (MO): Dividend ex-date: 12/23/05 Yield: 4. Find diabecon online 27% / year payable: 1/10/06 in amount of $. 80 per share Stock Price on Thursday, 12/1/05 @ $73 1/4 (MO) Option price Dec 75 Put @ 2. 00 and expiration date 12/16/05 (16 days out) Steps in implementing this strategy for Altria: 1. Search for a stock with an ex-dividend date after the expiration for the month. 2. Write a put that is ITM to force assignment at expiration (12/16/05); you would receive $2. 00 per share or $200 for one hundred shares. 3. In this case, the strategy would have not been completed since the stock rose sharply on December 15th and stayed over 75 past the expiration date. 4. On 12/16/05 the option expired worthless and the entire $2. 00 was kept for a return of 2/75 or 2. 7% in 16 days or 60% annualized. Data for an example with (): Dividend ex-date: 11/30/05 Yield: 4. 64% / year Payable: 1/3/06 in amount of $. 38 per share Stock price on Thursday, 11/3/05 @ $29. 50 (MRK) Options price Nov 30 Put @ . 65 and expiration date 11/18/05 (15 days out) Options price Dec 30 Call @ . 70 on 11/28/05 with stock at $30 with an expiration date of 12/18 Steps in implementing this strategy for Merck: 1. Search for a stock [find diabecon online] with an ex-dividend date after the expiration for the month. 2. Write a put that is ITM to force assignment at expiration (11/18/05); you would receive $. 65 per share or $65 for each one hundred shares. 3. In this case the stock closed at $30 and was assigned. We had to purchase 100 shares at $30 for $3, 000. A for the month of December was written for $. 70 4. On 11/30/05 MRK went ex-dividend and $. 38 / share was locked in for payment. 5. On 12/18/05 MRK was still at $30 and the shares we owned were called away or assigned. In summary, the results for our 100 shares of MRK were: Income from the Nov 30 Put = $65. 00 Income from the Dec 30 Call = $70. 00 Income from Dividend 1/3/06 = $38. 00 Total = $173 in about 43 days We have collected income from 3 sources totaling $173: Return = 173 / 3, 000 = 5. 77% in 43 days As you can see this strategy is a neutral to bullish strategy. It works best for the rising stock with a high dividend. The worst-case scenario is when a stock declines. If it declines it has an even higher probability of being assigned. However, the higher put premium will not make up for the decline. The stock will be acquired for the higher strike price and the decline will not be compensated for since the time premium is very low on the ITM put. Once the stock is acquired you can start writing covered calls and slowly make up for any losses. At some point, however, you need to face the fact that the stock may not have been a good pick and simply exit with a loss. Another more advanced technique for protecting this position is to form a collar spread. The site has the capability to search the entire universe of options to find that fit the criteria of: * An underlying stock with an option expiring in only 30 or 60 days * A naked put return over a certain value * A put that is ITM by a specified amount * A stock with a bullish broker recommendation and/or technically trending up * A stock with a dividend over a specified value * A dividend date that is within 30 and 60 days Depending on your level of service you can scan the entire market every 20 minutes-or in real time-to find these kinds of opportunities. Screening criteria, such as listed find diabecon online above, can be named and re-run every day to find puts with a dividend twist. Click for a glossary of . Good fortune! Technorati Tags: , , ,

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