Selling Put Options My Way

by Jerry Lee

  Jerry L. Lee – Selling Put Options My Way -

  Selling Put Options My Way

  How to create a steady stream of income using Put Options.

  Jerry L. Lee

  Contents

  Introduction

  1. My Investing History

  2. My Personal History

  3. Learning Some Basic’s

  4. Options and Related Definitions

  5. Margin and Maintenance

  6. Buying and Selling Puts

  7. Who Should Sell Puts

  8. Three of the Most Common Questions

  9. Intrinsic and Related Time Value

  10. Let’s Start Trading

  11. Shocking Idea

  12. Trading Strategies

  13. Analyzing a Previous Trade

  14. How to Avoid Problems While Selling Puts

  15. Why Option Premiums Change in Price

  16. Bid and Ask

  17. Taking Profits

  18. Naked Calls

  19. Ways to Maximize Your Profits

  20. Paper Trading

  21. Options Traps That Might Mislead You

  22. Where Do I Find the Stocks That I Use

  23. Some Thoughts

  24. Stock and Option Newsletters

  25. Summary

  Introduction

  I must start by telling you that I have no 1-800 number, I am not trying to sell you any products, and am not inviting you to come to my house to view a cleaning agent. I will not try to sell you plastic bowls or any other “can’t miss” ideas. I do not have any life-changing strategies to offer nor do I sell recordings that promise you unlimited wealth, inner peace, or a flat stomach.

  I am going to tell you the true story of how I have made a fortune, lost a fortune, and came back from the edge of disaster to prosper in the option market. I started with a modest amount of cash; also, I was lucky as I stumbled into the Internet bubble through accident and ignorance. Other than the school of hard knocks, I have no special talent or training in the stock market. My good and bad trades have been learned the hard way.

  I will also tell you how I now invest, and how it might work for you. If you find that it does, great. We both will be winners. I am not writing this book with the hope of making much, if any, money. I am now retired and healthy, golf several times a week, have a loving wife, two great daughters, and two good guys for sons-in-law. We are also blessed with four healthy grandchildren and sponsor a child in Mexico with whom we enjoy trading letters and pictures. Life has been very good to me, and giving some back will be my reward.

  I also am not a certified financial planner and only hope that I can convey what has worked for me. Once you read the book and start your own financial journey, I have no control as to whether or not you will follow my ideas. Your results might be different from mine. I hope better but maybe not. You alone must make the decision whether this strategy will fit your investment goals.

  Read the book several times. I hope that each time, it will become clearer. You may find the material confusing the first time you read it and it may sound like a new language. However, each time you go through it, you will better understand my ideas and rules for trading options. My style is not the only way to trade options and these ideas are definitely not the only way to sell puts. My methods are a way for the average investor to sell puts with some rules and guidelines.

  You will not need to learn the Japanese Candle Stick chart system or other unusual tracking methods. Just a few simple things to check each month, then make the trade and pocket some “free money.”

  CHAPTER 1

  MY INVESTING HISTORY

  I started utilizing options in the mid 1990s with approximately $150,000 in my account. At this point, you might be thinking, “Sure, $150,000. Anyone can make money if they have that much to start with.” However, the other side of that equation is that anyone can also lose money if they have that much to start with. Keep in mind that this money was also my family’s entire retirement nest egg. This had been saved by investing in some small apartment buildings and by working two jobs for thirty years. I had also received some accumulated vacation pay upon my retirement as a captain from the fire service. During our working life, my wife and I had economized and not wasted money. Over the years, as our savings grew, we did not rush out and buy new cars or other toys. That came later.

  I then entered the investing arena with little or no knowledge of its workings. I tried a few stocks that friends had mentioned. The friendships worked out fine, but the stocks never seemed to do nearly as well as the friendships.

  At some point in late 1996, I was introduced to the possibilities of trading options. I jumped in and went for quite a ride.

  With my lack of investing knowledge, I was cautious at first, but then money started flowing into my account. Stocks like Amazon, Dell, Microsoft, and others so-called Internet stocks just would not go down. These stocks seemed to split and double once or twice a year. Money really seemed free then, and within two years, my account had grown to over one million dollars. Officially, I was a millionaire.

  I was taking the whole family for trips to the Caribbean and Mexico, and we were staying at rented villas on the beach. One time, we could not find flights that fit our schedule, so we gave some serious thought to chartering a corporate-style jet.

  During this free-money ride, I had become a contributor to an open web page forum on options. I was getting a hundred or so emails monthly asking for opinions, ideas, and “next great plays.” I decided to surprise my wife with a new car and went to the local Mercedes dealer where I ordered a new S-500 for $92,000. When asked how I wanted to finance the car, I casually said, “I would write a check, of course.” A month later, I also bought a new Suburban and paid $42,000 cash for it. Only eight years before this, we were driving a $150, 1962 Rambler as our second car. My, my, how things had changed!

  My account had now increased to about two million dollars in just four short and very fast years. These were heady times for sure. There was free money everywhere I turned.

  I was a retired firefighter captain with a couple of years of college courses, but I had no official degree. By accident, I had found my niche in the financial market place. I was bulletproof, so I was taking chances and making wild options plays. Then, in late 1999, I started hearing the phrase, “Internet bubble.” Yeah, sure. Didn’t the naysayers understand that this was a new paradigm with no end in sight? I was seeing older traders on TV interviews saying, “You young guys haven’t been around long enough to see a down market.” My thought was, “Get the old codger off the TV and show me some more options.” When I look back, I was so full of myself, but damn, it was fun!

  Then 2000 came along, and it seemed that a few of the Internet stocks had slowed their growth rate. Not to worry, the upward movement of the NASDAQ during the late ‘90s had not been just a straight line up! There had been times when stocks moved down some, but then went right back up on the correct path. Therefore, as a downward trend started, I failed to recognize it. Failed to recognize it, hell! It was slapping me in the face, and I still flat out ignored it!

  I will show you later how I could have prevented the devastating results of 2000-2002 to my account. However, at that time, I still felt bulletproof. I had no rules or experiences to fall back on. When I look back, I was so inexperienced that it surprises me that I kept any money at all. I was selling puts and using the entire margin that my brokerage would let me use. I was still picking strike prices at, above, or very near, the current price of these Internet stocks. Surely, these stocks would turn around and bail me out. Then the famous (well, famous is not the first word that comes to mind) margin calls started. I think my brokerage had my phon
e number on speed dial. I was forced to liquidate position after position and my account balance was plummeting. By late summer, my account had dropped to approximately $750,000, so I had lost about 1 ¼ million in six months! Hmmm, I wondered if I could buy that 1962 Rambler again.

  The news did not get any better. I was just about to the point where I needed an intravenous line of Pepto Bismol. If I had made all that money once, I could do it again! “Wrong again, little Grasshopper.” I was like a gambler trying to get even by doubling his bets. The account continued to drop, and somewhere along the way, I decided to cut my losses and get out of the market. Once I had stepped back a little, I found I could see more clearly.

  It was now mid 2002, and my wife and I sat down and tried to figure what the best investment strategy for us was. We decided to take some time off from the market and let things settle down. During this time, I tried to look back and make some sense of what had just happened. In four quick years, I had become a multi-millionaire. Two years later, I was nearly back where I started. I now saw many places where I was foolish, ignorant, and just plain stupid.

  Making Rules

  I began to make some rules regarding my trading habits. Once the list was pared down to only a few important rules, I tried to look back to see if they would have saved me some money and anguish. The short answer was yes, lots of money and even more stress.

  Somehow, my investment style does not seem to appeal to many professionals—or at least they do not share it with the non-professionals. Many professionals might argue that the risk of utilizing options, and especially put options, is not worth the reward. My style of investing is somewhat risky, but controlling risk and following my simple rules, and some that you might implement for yourself, will minimize this risk.

  Driving a car is also risky, but you minimize that risk with seat belts, good automobiles, and safe driving habits. Just like driving a car, options require that you pay attention. Follow the rules and treat all situations seriously. If you do these things, then the risk are minimized and the rewards can compound quickly. Options and automobiles are somewhat alike. The same people and the same styles always seem to experience the most wrecks.

  Many friends have asked me why I am going to the trouble to write this book and will it hurt my potential earnings if many others do what I do? About the trouble of writing this small book, I must admit that I enjoy writing and have had many articles published in national magazines about my sailing and outdoor adventures. As to the possible loss of earnings from readers becoming my competition, there are plenty of options to go around.

  I sincerely hope that the ideas presented here will help you and your family discover a source of income that will open some doors and possibly bring you a better life. Money certainly will not guarantee happiness, but struggling and not getting ahead can also be short on rewards. Knowing that I can send my grandchildren through college is a great feeling, and for my wife and I to be able to fully enjoy our “golden years” is a true blessing.

  I do not remember ever reading any books that will expose you to my type of trading. I am sure that there are thousands of traders out there doing it this way but if so, they are not writing or talking about it. However, this is not a new or complicated method nor is it hard to learn. Most people who have looked at my way of investing feel that it is very easy to understand. In this book, I will show you what I do and how it might work for you.

  CHAPTER 2

  MY PERSONAL HISTORY

  I was brought up in a middle-class family in Los Angeles during the 1950s and early 1960s. I graduated from high school and promptly entered a technical college to become a draftsman. After two months, the instructor and I both felt sure that I was not destined to work indoors or to wear a tie for the next forty years, so I dropped out of school and went to work for a construction company. I quit that job and joined the army to become a paratrooper. I spent the next three years jumping out of perfectly good airplanes. I received my honorable discharge and, having just married my sweetheart from “back home,” I again joined the labor pool in Los Angeles. I had heard talk around the various job sites of the advantages of a career in one of the fire departments near the Los Angeles area, so I took my first civil service test and scored right at the top out of several thousand applicants.

  Thirty years later, my wife and I were in Seattle, Washington. We had moved from the Los Angeles area to Eugene, Oregon, and then on to Washington and the Seattle Fire Department. I still had the same, albeit even more beautiful wife, two grown daughters, and was now ready to retire from the fire service. During my years with the department, two friends and I had made some investments, including buying a duplex and two small apartments buildings.

  With the money my wife and I had saved, and by selling our interest in the apartment business, we were free to play for a few years. We had no bills, and our two daughters were out of college and doing very well. It was a perfect time for us.

  Through the years, I had done quite a lot sailing around the Puget Sound area with various friends. I had always loved boating, especially sailing. Cheri and I ordered a sailboat from a company in the Chesapeake Bay area. Our plan was to sail and/or motor the Intracoastal Waterway from Maryland down to Florida and then have the boat shipped back to the Seattle area. We completed this trip in four months and had a fantastic time.

  My Introduction to Options

  Among the items we took on our boat trip were some books to read in the evening. I had seen one about options on the bestseller list. Hmmm, I thought, I wonder what that’s all about. I bought the book, and this started my odyssey in the option world, which has not yet ended. The author painted a glowing picture of the possibilities of using options as an investment strategy. During our trip along the East Coast, I read the book twice. I would not be surprised to hear that the author is now in jail, in Brazil, in a Turkish prison, or maybe even in the witness protection program. He had charts laced with numbers, graphs, and sundry ideas on how you, too, could become rich by using “his” ideas. At the end of his book was a phone number for people to call, and for a “very small fee,” he would share with you his option predictions. I did not make that call, but the possibility of using options to make money was intriguing, to say the least.

  After our boat trip, we returned to Washington State and settled into our retirement. Option trading and the possibility of big money had certainly interested me. I had become acquainted with a stockbroker over the years, so I gave him a call and asked his opinion of the option book and his general feeling on options. He advised me that using options could be risky but that they did present a way to make very good money, even with a small starting capital. Hey, that was for me! He also advised me to avoid the previously mentioned 1-800- number and asked if I had heard of a method of trading options called, “selling puts.” I had to admit that I really knew very little about options and even less about selling puts. I had read of calls and puts and assumed that you bought one or the other, then crossed your fingers, quit beating your dog, bought your wife flowers, and then hoped for the best.

  Let me tell you that there certainly is plenty of money to be made with buying calls and puts, but I do not buy them, I sell them, which is a strategy called “being naked.” This does not mean that I do my options trading from a nudist resort. It means that I do not have what I am selling—puts and calls.

  I must admit that the idea of “short selling,” or selling something that you do not own, always baffled me. Yes, it can be confusing at the start. It is a foreign idea to most of us who are new to Wall Street. I hope that I can make it easy for you to understand and also simple and fun. With preparation, care, and diligence, selling options might put you on the road to some very interesting financial rewards. My broker says that when he first started doing naked puts, he ran out into the hallway near his office and yelled “free money in my office!” Well, it can be free if you are careful or it can be very expensive if you do not show some discipline and follow
some simple rules. Believe me; I know both sides of that story.

  Throughout the book, I will be using the term “selling puts.” It should be said that selling a put is technically called ”writing” a put. The term started because the seller wrote the contract and therefore was the writer. However, when dealing with most, if not all, brokers, it is now referred to as selling. You will be selling an option, which will open a position.

  In my early research, I had read that approximately 90% of option buyers lose money, which is a scary number. Even a retired fire department captain like me might ask, if 90% lose money when buying options, then who are the 10% who are making money? Can these people be smarter, have more information at hand, or perhaps use tarot cards? Just what separated the 90% crowd from the 10% crowd? I knew that whoever the 10% crowd was, I wanted to join their team.