WBD - 10 Trades To Get 10%+ Yields From S&P 500 Stocks Without The Market Exposure

Summary

• Safe and double-digit yield is not something you get every day.
• You can, however, achieve both, by combining a sound strategy, expertise, and technology.
• Here are 10 double-digit yielding trades with S&P 500 stocks.

Written by Sam Kovacs.

Introduction

High returns with low risk...

It sounds like a proposition too good to be true.

In many cases, it is.

But as you know, once in a while, there are mispriced opportunities in the market which allow you to get high returns with low risks.

Academics say this is impossible. Markets are efficient.

Only, markets aren't efficient.

In fact, they often give prices which are either too high or too low.

One place where this happens more than ever is the options market.

It is a lot less liquid than the equity market, which spells opportunity to investors who know how to exploit it.

Later this year, Robert & I will be launching a new Investment Group on Seeking Alpha which will provide tech, education, and the expertise required for investors to generate high returns with limited market exposure.

In the meantime, we're giving away the best trades for free, so you can get a taste for how our system works.

The option selling strategy

Here is a basic overview of the strategy we will deploy to maximize income selling options.

• We sell out-of-the-money cash secured puts to collect premiums which offer a high annualized yield.
• we repeat the options selling cycle every time an option expires worthless.
• If we're assigned, we take ownership of the stock. We then instantly start selling covered-calls at the price at which we were assigned the stock, which generates yield.
• Hopefully our call options get assigned, and we part ways with the stock. The quicker this happens, the more "market neutral" our portfolio will remain. This means that our returns are driven by selling cash secured puts most of the time.

It becomes clear that we have two key risks to manage:

• The first is the assignment risk: what percentage of times do our cash secured puts get assigned? We will look at ways to minimize this.
• The second is market risk of assigned stocks. If we get assigned stock, we don't want the stock to crater. We will explain how we address this.

Why selling puts is like selling insurance

Selling put options is similar to running an insurance business in the sense that the seller of the put option is essentially offering a form of insurance to the buyer.

When an insurance company writes an insurance policy, they are accepting the risk of a potential loss in exchange for a premium. If the event insured against does not occur, the insurance company keeps the premium and the policyholder receives no benefit. If the event insured against does occur, the insurance company must pay out a claim, potentially realizing a loss.

Similarly, when a seller writes a put option, they are accepting the risk of potentially having to purchase the underlying stock at the strike price in exchange for the premium received. If the stock price remains above the strike price, the option will simply expire worthless and the seller will keep the premium. If the stock price drops below the strike price, the buyer has the right, but not the obligation, to exercise the option and sell the stock to the seller at the higher strike price, and the seller must purchase the stock at that price, potentially realizing a loss.

In both cases, the seller is taking on a limited amount of risk in exchange for a premium, similar to how an insurance company takes on the risk of a potential loss in exchange for a premium.

This is a particularly interesting proposition, as insurance businesses are notoriously stable, generating more income than they have to pay out in nearly all scenarios.

They can achieve this because they have expertise and extensive risk management skills, which allows them to price their policies to ensure a profit.

The lesson to be learned is that to generate high profits by selling put options, we need to sell the options at the right price for the risk we are taking.

We need to be able to measure our profitability and our risk accurately.

Measuring profitability and risk.

Measuring profitability of options is quite straightforward. The premium you receive when selling an option is your yield.

You are getting paid that yield for locking up your cash for a certain number of days.

For example you might get a $1 premium on a $100 strike within 30 days.

$1 is 1% of $100. 30 days is 1/12th of a year, so your annual yield would be 12%.

Quite straightforward.

To measure the risk, we calculate a metric we call "assignment risk."

In an ideal world, we would never be assigned. When you're selling puts, your cashflows look a lot like those of an insurance company. You collect payments, and in exchange insure your counterparty's position up to a certain price.

Just like an insurance company, you want to maximize your premiums, and minimize the percentage of times you have to pay out.

So, we avoid selling options which will span earnings announcements, as these are binary events which can move the price aggressively in either way.

To avoid being assigned we also implement a margin of safety when selling puts. The margin of safety is simply the distance between the current price and the strike price.

For example: If a stock trades at $100, you have a bigger margin of safety on an option with a strike price of $80, than you do on an option with a $95 stock price.

All things held equal, a higher margin of safety leads to reduced risk.

But things are not held equal, because different stocks have different levels of volatility.

Adjustments need to be made to take this into account on a stock-by-stock basis.

Also, the required margin of safety depends on the number of days until expiration.

This is obvious: the price stands to move less over 7 days than it likely will over 30 or 60 days.

This might seem like a lot of things to consider, but we have figured out how to take all of these things into account with one ratio: Assignment risk.

Assignment risk is calculated by looking back over a period of time (we use 1 year) and counting what percentage of time the max drawdown in x days is greater than the margin of safety. The number of days corresponds to the days to expiration.

We want this number to be low as possible. A 10% assignment risk means that you expect to be assigned on 1 trade out of 10.

In our experience, assignment risk is superior to the Black & Scholes implied volatility's expected moves, which rests on the hypothesis that stock prices follow a normal distribution.

It is our experience that stock prices are positively skewed with fat tails and excess kurtosis, looking anything but normal.

However, we will still look at how many standard deviations the strike is from the current price, based on the implied volatility metric, as a secondary means of assessing downside risk.

Finding trades

Knowing this is great, but this doesn't mean it is easy to find trades. There are tens of thousands of options being traded at different strikes and different expiration dates for so many different stocks.

More than a human can possibly expect to look through in a week, let alone in enough time to be able to take action on the data.

That's where we come in. We love to find technological solutions to human problems.

It turns out that computers don't get headaches when sifting through over 100,000 options in a few minutes.

We use our proprietary assignment risk calculation along with our option screening algos to find the perfect trades for our strategy.

Without further ado, here are 12 trades you can execute now to generate double digit yields as high as 27.9%.

All of these options are on the monthly contracts expiring March 17th, giving investors a mere 17 days exposure to the market.

We've also screened to make sure that none of these stocks have earnings announcements happening before the expiration date. It is best to avoid options which expire after an earnings date, as the announcements can cause extreme volatility, which can play against us.

You should look out for things like ex-div dates, which can also reduce share prices, as well as anything material which might happen between now and the expiration. At least to the extent you can plan it. For example, we're staying away from Adobe Inc. ( ADBE ) options right now, because of the fear surrounding a possible DoJ lawsuit.

As option prices can move quickly and have significant bid/ask spreads, I will give you the current yield based on the bid, which is the price at which you could execute the trade right now.

I'll also provide a "minimum premium to get a 10% yield," so that you have a point of reference for how low to go to not compromise your yield.

Trade 1: Signature Bank

Signature Bank ( SBNY ) usually isn't given the time of day in our day-to-day investing at The Dividend Freedom Tribe.

It yields 2.5% and has only been paying a dividend since 2019, which it increased for the first time this year.

And sure, the company has its fair share of problems, but the Q4 earnings have been released, and the shares have gone ex-div, which increases the odds that the stock does not see a 12% decline in the next 17 days.

But right now, you can sell a Put option with the $100 Strike, and collect $1.30.

Below are the details of the trade:

• Contract name: SBNY230317P00100000
• Expiration: March 17th
• Strike: $100
• Premium: $1.3
• Yield: 27.9%
• Minimum Premium for 10% yield: $0.48
• Margin of Safety: 12%
• Assignment risk: 6.8%
• Standard deviations safety: 4.25 std
• Cash required: $10,000.

As long as you get to sell for at least $0.48, you'll collect an annualized 10% yield. The contract has a 93.2% chance of expiring worthless, making it a brilliant deal if you can get closer to the current bid.

Because of the $100 strike, you do need to set aside $10K in cash to cover the option, so this trade is not suitable for the smallest portfolios. At the very minimum, you'd want a $100K option portfolio to consider this trade. It would carry a lot of concentration risk if doing so, so I'd suggest keeping this for portfolios worth at least $200K.

Dish Network

DISH Network Corporation ( DISH ) is a stock we don't cover, which has lot of problems, having experienced a couple of 8% decline days in the past two weeks, and seeing the price drop to the lowest level since the summer of 2009.

But there are great deals on the puts that yield as much as 21%. Consider the following contract.

• Contract name: DISH230317P00010000
• Expiration: March 17th
• Strike: $10
• Premium: $0.12
• Yield: 25.8%
• Minimum Premium for 10% yield: $0.05
• Margin of Safety: 18%
• Assignment risk: 2.3%
• Standard deviations safety: 4.8%
• Cash required: $1,000.

This contract has a very low chance of expiring in the money, which means you should be able to collect and move on. Because of the low share price, it is appropriate for option portfolios of all sizes.

Warner Bros. Discovery

Warner Bros. Discovery, Inc. ( WBD ) bottomed around $9 in December, and has rallied to $16 since, with the market reacting positively to its earnings report.

The following contract offers particular value to short option traders.

• Contract name: WBD230317P00014000
• Expiration: March 17th
• Strike: $14
• Premium: $0.14
• Yield: 21.5%
• Minimum Premium for 10% yield: $0.07
• Margin of Safety: 12%
• Assignment risk: 9.86%
• Standard deviations safety: $4.62
• Cash required: $1,400.

This contract offers a good yield, but it has a near 10% assignment risk. Because of this, and the fact that WBD has moved sharply up in a short period of time, investors need to make sure they're getting enough of a premium for the risk taken.

If you can get between $0.1 and $0.14 you're getting a good deal, below that I'd prefer the other options on the list.

WBD is another stock whose options can be traded by portfolios of all sizes due to the low strike.

Tesla

Tesla, Inc. ( TSLA ) is not a stock which we're interested in as dividend investors. But the stock's volatility means it routinely offers premiums, which are very alluring.

Remember that it's a double-edged sword, as anything Elon might or might not say has pushed the stock up or down on more than one occasion.

TSLA has traded as low as $119 in December, and has risen back up to $207 in the past couple of months.

Nonetheless, the $165 strike option offers a particularly good yield at this point.

• Contract name: TSLA230317P00165000
• Expiration: March 17th
• Strike: $165
• Premium: $1.29
• Yield: 16.8%
• Minimum Premium for 10% yield: $0.77
• Margin of Safety: 20%
• Assignment risk: 0% (it's never really 0)
• Standard deviations safety: 5.45std
• Cash required: $16,500.

This is a particularly good trade, especially if you can collect north of $1 per share on the contract.

However, because of TSLA's share price, this option is really only to be considered by investors with portfolios of $250K to $300K minimum.

VF Corp

V.F. Corporation ( VFC ) is a stock we actually cover, and did a poor job in anticipating the dividend cut.

If investors want to make up for that income, they can look at the following option.

The stock is currently trading at $24.

• Contract name:VFC230317P00021500
• Expiration: March 17th
• Strike: $21.5
• Premium: $0.15
• Yield: 15%
• Minimum Premium for 10% yield: $0.11
• Margin of Safety: 11.6%
• Assignment risk: 6.7%
• Standard deviations safety: 4.7std
• Cash required: $2,150.

This is a great option if you can get north of $0.11, as there is nothing material, except the ex-div date on March 9th which can push the stock down $0.3 or so. Most likely not enough to prevent you from collecting your premium without assignment.

Domino's Pizza

Domino's Pizza, Inc. ( DPZ ) is a stock which I've had on my radar for a long time. I believe my younger brother and I probably contributed to 1/3rd of its European growth throughout our university years.

However, the stock has been hit with a handful of downgrades in the past week, which is creating demand for insurance on the stock price, which has declined to a level not seen since 2018. It currently trades at $295.

Relative to its dividend, it is now as undervalued as it has ever been since it reinstated its dividend 10 years ago.

This creates an opportunity for us to generate a nice big yield from the options.

• Contract name: DPZ230317P00270000
• Expiration: March 17th
• Strike: $270
• Premium: $1.6
• Yield: 12.7%
• Minimum Premium for 10% yield: $1.26
• Margin of Safety: 8.67%
• Assignment risk: 9%
• Standard deviations safety: 4.7std
• Cash required: $27,000.

Once again, here because of the relatively high assignment risk (we always focus on assignment risk less than 10%) if you cannot get close to the $1.6 mark on the premium, I'd advise investors to sit on the sidelines for this one.

Also, the large required cash position for the option makes it unsuitable for investors with less than $400K in their options portfolio.

Digital Realty

Digital Realty Trust, Inc. ( DLR ) is a stock which we like and own, and believe that the market is wrong about.

Instead of owning the stock outright, why not sell an option and collect more than double the yield of the underlying?

DLR currently trades at $105.

• Contract name: DLR230317P00095000
• Expiration: March 17th
• Strike: $95
• Premium: $0.55
• Yield: 12.4%
• Minimum Premium for 10% yield: $0.45
• Margin of Safety: 9.42%
• Assignment risk: 9.2%
• Standard deviations safety: 4.92std
• Cash required: $9,500.

I believe this is a good option trade. The ex-div on March 14th can decrease the price by $1.2 or so, which is to be monitored throughout the life of the trade.

Intel

Intel Corporation ( INTC ) recently disappointed many dividend investors like myself. The volatility around the stock has created the opportunity to sell an option and collect a higher than average premium. Intel currently trades at $25.

• Contract name: INTC230317P00022500
• Expiration: March 17th
• Strike: $22.5
• Premium: $0.13
• Yield: 12.4%
• Minimum Premium for 10% yield: $0.11
• Margin of Safety: 9.6%
• Assignment risk: 9%
• Standard deviations safety: 5.2std
• Required cash: $2,250.

This trade is also rather interesting provided you can get closer to the $0.13. Intel has found support 3x around the $25 mark, and it is a good risk adjusted trade to bet that it will do this once more.

Baxter

Baxter International Inc. ( BAX ) has been on a continual decline for the past year. This should cause investors to pause, as the stock has not seemed to find any support so far, declining from $85 to $40.

The upside is that we have a very good idea of by how much BAX tends to move on a 17 day period, given that it mostly hasn't gone up at all in the past year.

Below is the distribution of 17 day max drawdowns for BAX during the past year.

The vertical axis shows the number of instances, and the horizontal shows the max drawdown in % points over 17 days.

If the value is positive, it means that over 17 days the stock price didn't go below its starting price.

As you can see, the bulk of the max drawdowns are between the 0% and -8% range.

The fact that this tail between -6% and -10% exists creates our assignment risk for BAX.

• Contract name: BAX230317P00037500
• Expiration: March 17th
• Strike: $37.5
• Premium:$0.2
• Yield: 11.5%
• Minimum Premium for 10% yield: $0.18
• Margin of Safety: 5.8%
• Assignment risk: 8.8%
• Standard deviations safety: 4.18std.

3M

3M Company ( MMM ) is the last option which we'll present in this already very lengthy article.

I am also introducing the Distribution chart of 17 day returns for 3M to show some differences with BAX (also as a little gift for reading us this far).

As you can see, 3M has had a significant amount of down periods where the stock has had max drawdowns of 10% to 16% over 17 days.

But unlike BAX, MMM has a large body of positive returns between 0% and 10%, with a very long positive tail.

The below option is a good risk/reward

• Contract name: MMM230317P00101000
• Expiration: March 18th
• Strike: $101
• Premium: $0.54
• Yield: 11.5%
• Minimum Premium for 10% yield: $0.48
• Margin of Safety: 6.7%
• Assignment risk: 8.2%
• Standard deviations safety: 4.67std.

Provided you can get a premium of $0.48 to $0.54, this trade gives a good risk reward.

Conclusion

Selling cash secured puts is a brilliant way to get consistent returns with less market risk, which can be very lucrative, especially when you are unsure about the overall market direction.

If you liked this article, please share your thoughts in the comments, and make sure you follow us for news on the High Options Income Circle when it gets closer to launch.

For further details see:

10 Trades To Get 10%+ Yields From S&P 500 Stocks Without The Market Exposure