How I Collected An 8.7% Yield In Just Under 3 Months

StreetAuthority Network

A little over a month ago, I told you about an income strategy that generates hundreds or even thousands of dollars in "Instant Income" a week. 

It allows investors to do one of two things: either earn large amounts of income -- or buy high-quality stocks at a deep discount. 

My strategy involves selling puts on undervalued, high-quality stocks. And as you'll see today, it's the closest thing to a win-win strategy in the financial markets.

To recap, put options give investors the right -- but not the obligation -- to sell a stock at a specified price before a specified date. Selling a put obligates us to purchase that stock from the put buyer if it falls below a specified price (the option's strike price). When we accept that obligation, we receive cash, or what I call "Instant Income," upfront (known as a premium).

Below are all the puts I've recommended in my Income Trader newsletter that have expired, meaning the buyer of the put can no longer ask us to purchase shares.

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Now, if you remember, when an option expires, one of two things will happen: 

1.) The option expires worthless, meaning the trade is closed, and the "Instant Income" we collected is pure profit. This happens if shares are trading above the strike price when the options expire. In my experience, this happens about 85% of the time.

2.) The option expires "in the money," and we are assigned 100 shares of the underlying stock for every put contract sold at the strike price. This happens when shares are trading below the strike price when the options expire.

As you can see, on average, we've generated close to 8.7% in "Instant Income" on our money since February. That's an annualized gain of 50.9%.

Not bad. But today I want to focus on the April $55 Puts for Joy Global (NYSE: JOY), the global mining equipment giant, which were assigned to us on April 22, the Monday after the options expired. 

Although we bought the shares at $55, our cost basis is actually a bit lower. When we sold the puts, we received a premium of 93 cents per share, so our cost basis is $54.07 ($55 - $0.93). So that means we got a nice little discount on every share we now own. (Remember, I only sell puts on high-quality stocks I would not mind owning, so being assigned shares is not a bad thing.) In fact, we're already nicely ahead on this trade. Factoring in the discount, if I turned around and sold the shares at Tuesday's closing price of $56.52, we'd have a 4.5% gain.

But instead of selling shares, I want to generate even more "Instant Income" first. That's why I recommended my Income Trader readers sell JOY May $55 Calls for $2 on April 25.

There are two possible outcomes with this strategy.

1. Selling this call generated $200 in "Instant Income" per contract sold ($2 x 100 shares). If JOY is trading above the $55 strike price when the call expires at the close on May 17, we'll have to sell 100 shares of JOY at $55 for each contract sold. 

But remember, our original cost basis was $54.07. And after getting $2 per share this time around, our cost basis is again lowered to $52.07. Essentially, we're getting paid upfront to sell shares at a 5.6% gain. That may not sound like much, but it only took us 24 days to do it. (For the record, that's an annualized gain of 129%.)

2. Worst case, if JOY trades below $55, we will continue to own the stock and have an opportunity to sell another call after this one expires, which will generate even more income and lower the cost basis on the stock even more.

If JOY trades for less than $55 on May 17, we'd keep the $200 per contract and continue to own the stock. In this case, we'd own JOY at a cost basis of $52.07, which is 7.9% below current prices. 

Our $52.07 cost basis is just 8.4 times estimated 2013 earnings. That's not bad for the leading manufacturer of equipment used in mining copper, coal, iron ore, oil sands, silver, gold, diamonds and more. Not to mention we'd receive a quarterly dividend of 17.5 cents per share. Plus, we could sell covered calls on the position to generate additional income at any time we want.

Action to Take --> In short, generating "Instant Income" from quality stocks is where investing gets fun -- you almost can't lose with this strategy. You either get to generate a consistent "dividend" of sorts -- or you get to own quality stocks at a discount to the market prices. And in some cases, you get to do both. Any way you play it, you're looking at a win-win situation -- a rarity in the financial world. 

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