The 3 Pillars That Reduce Risk When Selling Options

During their recent episode of the Value Options Letter and Acquirers Podcast, Travis and Tobias discussed The 3 Pillars That Reduce Risk When Selling Options. Here’s an excerpt from the episode:

So these are kind of risk reduction, income enhancement strategies. So let’s go ahead and move forward here. So here’s kind of the pillar.

So the first pillar is that the stock’s already cheap. The second pillar is that we’re already dealing with undervalued stock. Now we’re selling a put or we’re doing a covered call that’s going to manufacture a cheaper entry price into the stock.

And then the third pillar is that the premium that we collect itself is going to reduce the entry price as well. So there’s three pillars of protection, multiple ways that we’re setting you up for success on this publication. So here’s an example of the math.

So let’s say that we have a stock where our fair value estimate is 120. The stock today is trading at 100, which is 17% below the fair value. We might sell the $90 put for $4.

So if you get exercise, your effective entry is $86. So that’s 14% below today, 28% below our estimate of fair value. And so there’s three pillars stacked right there, the intrinsic discount, the strike below spot, and the premium.

So that’s all the margin of safety. Benjamin Graham, focus on margin of safety. That’s how we do that with vol.