From my post How To Make Money Going Naked, I described selling puts. It’s really simple to do. The terminology is the hard part. So here’s what I did.

Since we are in April, I’m going to change the example from March puts as used the previous post to May for illustration purposes.

Let’s say I sold a May $10 put for $1. I got paid $100. ($1 x 100 shares since 1 option controls 100 shares.) I secured the option with cash equal to $1,000. ($10 x 100 shares).

Uh oh, the price of the shares is now below $10 down to $7. I’m going to have to buy the shares when I the options get exercised and lose $2 per share or $200 dollars next month if the price stays at $7. ($10 – $1 = $9 – $7 = $2 per share) Or, I could close out the position and take the loss on the option.

However, I don’t want to do either. I don’t feel like losing right now.

So, to prevent getting exercised, I rolled out my option from May to July. Maybe I should wait, but time is my friend and I don’t have time to be a day trader.

Here’s the math. I will lose on buying back the May option. Selling first, buying later. The price of the option is $3.25 and I sold it for $1. Therefore, I lost $2.25 per contract. But at the same time I’ll sell a July option for $3.50 for a net gain of $.25 or $25.

In my example, this is an exchange traded fund that I really want to own or I wouldn’t have done it. If the fund goes out of business, I would have lost if I purchased the shares at $10 anyway. But I don’t see it happening. Some of the companies within the fund may go out of business, but they should be replaced with new ones.

To continue on, I have my original $1,000 sitting in an account earning a small amount of interest. I have sold two options – one for $1 and the other for a gain of $.25 for a total of $1.25 or $125. To double check my math, the sequence of buying and selling the put options were: sold for $1, bought for $3.25, sold for $3.50 = $1 – $3.25 + 3.50 = $1.25

My plan is if the price of the fund stays below $10, I’ll roll it out again. If it goes above $10, I’ll let these options expire worthless and keep the money that I was paid and have pure profit.

I’ve earned $125 so far. If I have to buy the shares, my basis is $8.75 per share. I’ve reduced my loss and risk down from $10 simply by not purchasing them in the first place.

Here’s the cool part.

I have my $1,000 sitting tight not losing money, except for inflation. If all I do is roll out my option and earn $25 every 3 months, that amount is equal to $100 per year, or 10%.

In reality, I haven’t invested my money, so I’m making money – 100% pure profit.