Why Selling Cash-Secured Puts Can Reduce Investment Risk

During their recent episode of the Value Options Letter and Acquirers Podcast, Travis and Tobias discussed Why Selling Cash-Secured Puts Can Reduce Investment Risk. Here’s an excerpt from the episode:

[Tobias] Nobody can predict what the stock price does over a short period of time, certainly not in 29 days. It’s going to follow a random walk over 29 days. All you’re doing is either agreeing to buy the stock a little bit lower, which many value investors like to do that.

You buy a small position now, you might buy a little bit more if it goes down more and that you’re satisfied that the fundamentals remain unchanged because that should increase your margin of safety, increase your forward returns. And you can do that again. You have a wheel strategy where if it goes down more, you just undertake the same process to either sell some calls, sell some puts.

It’s just a way of generating a little bit of additional return when you’re already comfortable owning the stock. And over a 29 day period, we are going to see basically random movements because it’s such a short period of time. And so it makes complete sense to build in a little bit extra margin of safety.

If the stock runs away from you, then you should be satisfied with the internal rate of return that you’ve generated on the cash that you’ve put up. If the stock is put to you, then you should be satisfied that you’ve done enough work that you’re comfortable taking the stock. And if you do those two things over a long enough period of time, probabilistically, you’re going to do a little bit better than you would have if you’d just been buying the stock outright today.