Copyright 2014
Arrow Publications
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THE FOLLOWING IS THE AUTHOR'S PREFACE TO
PUT OPTION WRITING DEMYSTIFIED
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PREFACE
Have you been tempted at times to buy a particular stock, but decided not to because you thought it might be overpriced…or you thought you might be able to pick up the shares at a lower price at some time in the near future? Not only might it be possible for you to buy that stock for less, but what if someone were willing to pay you cash today at a double-digit rate and also give you the opportunity to buy it at a lower price later? Does that sound too good to be true? It’s not. It’s called put option writing, and it’s available to you on literally thousands of stocks and Exchange Traded Funds (ETFs), many of whose names you would recognize immediately.
Is this a risky proposition for the investor? Not if you are committed to buy the stock at a lower price anyway and have the resources to do it. Why is put option writing virtually unknown to individual investors? After more than twenty-five years of experience using options with investing and listening to what others have to say, here is my belief: people are easily intimidated by something they don’t understand. That applies not only to investments but to many things.
Early in my banking career we commissioned a research project on why certain segments of the population don’t use ATMs (automatic teller machines) more often. What we discovered was that people who don’t use ATMs avoid them for fear of looking stupid. They are afraid that someone will see them having trouble when they are trying to get cash out of the machine or trying to make a deposit. It’s not that they aren’t capable of making the ATMs work with their cards. They just haven’t been properly trained on how to perform these functions and they don’t want to be caught looking foolish. I’m sure we all have things we don’t try because we don’t understand them, and the fear of doing something stupid or being perceived as such is a great inhibitor.
I believe that this principle also applies to many individual investors about using options. If you visit any major bookstore you will find at least several books on the subject of investing using options, both puts and calls. Most of these books include all of the potential option strategies in a way that not only confuses investors but intimidates them as well. Puts, calls, futures, short/reverse/variable hedging, arbitrage, covered, uncovered, derivatives, combinations, swaps, bull/ bear/box/butterfly/diagonal/ horizontal spreads, binomial trees, Black-Scholes model, straddle…it seems to go on forever. Investors end up feeling stupid…rather than being educated…by these authors. Moreover, individual investors are left with the impression that those who use options are exposing themselves to huge risk where they might lose a substantial amount, if not all, of their investment. And that can actually be true for some uses of options. But what is unknown by almost all individual investors is that there are a few option strategies…not many, but a few…that are very conservative. Some are even more conservative than simply owning stocks alone. Used appropriately, writing put options can be one such conservative strategy, as is covered call writing.
For investors who would like to buy shares at a lower price than they are currently trading and would like to pick up some additional income (at double-digit rates of return) while waiting, writing put options can be a viable and profitable strategy.
Put Option Writing Demystified offers a turnkey program that delivers a comprehensive and easily understood education on the subject and also provides a complete program for self-implementation. It’s not at all intimidating and can be practiced and executed in the privacy of your home or office using your computer together with this book. And best of all, using the put option writing strategy fits perfectly with the slow-growth market we are expected to experience for years to come.

THE FUTURE ISN’T WHAT IT USED TO BE

Many investment experts and economists have been making public statements warning about investor expectations for the long-term future. This includes two prominent individuals: Warren Buffett, Chairman of Berkshire Hathaway, often referred to as the “Oracle of Omaha” for the incredible investment success he has achieved over the past four decades, and John Templeton, the now deceased mutual fund pioneer and founder of the Templeton mutual funds.
Unfortunately these experts are strongly suggesting that investors should not hope for anywhere near the level of investment returns from the stock market that they have come to expect over the past two decades. Buffett and Templeton believe that at best investors may only realize about 6% or 7% annual returns before taxes and inflation going forward. If this prediction from such highly qualified experts is close to accurate, new ideas will be needed for stock market investors to have any hope of achieving double-digit returns in the future.
When the enormous Internet, telecommunications and financial bubbles eventually burst, many of the investment “experts” people had come to trust either lost their jobs, or at the very least lost their credibility. Some were heavily fined for breaking securities laws. The dust likely won’t completely settle for years to come.
Yet through it all, we find that there are still real experts out there who can be trusted. Among them are Warren Buffett (Chairman of Berkshire Hathaway) and John Templeton, now deceased, (a pioneer in the mutual fund industry and founder of the Templeton Funds.
Many of these experts have been warning us that the generous stock market returns of the past should not be expected in the future. Warren Buffett, “The Oracle of Omaha,” is arguably the most successful investor in modern times, with average annual returns to his investors exceeding 25% annually since the late 1960s. As far back as 1999 Buffett, who had always been silent about his beliefs on the stock market, began to publicly express his concerns about the expectations that investors have for market returns in the future. He stated in Fortune that for perhaps the next decade or two, stock market returns would average about 6% per year after brokerage costs, but before taxes. Shortly thereafter the markets, particularly the NASDAQ, began their substantial fall.
He has not warmed up much to the market since that time. In one of his Berkshire Hathaway annual reports, Buffett commented:

Despite three years of falling prices, which have significantly improved the attractiveness of common stocks, we still find very few that even mildly interest us. That dismal fact is testimony to the insanity of valuations reached during The Great Bubble. Unfortunately, the hangover may prove to be proportional to the binge.

“Chairman’s Letter, “ Berkshire Hathaway Annual Report
And, following the annual meeting of his shareholders attended by 15,000 loyal believers, Buffett had the following to say in an exclusive interview with Maria Bartiromo of CNBC in which he seems to have lengthened his time horizon for slow growth in the market:
If you own equities, over the next twenty or thirty years you’ll get a reasonable return…maybe it’s 6%, maybe it’s 7%. People who expect 15% a year are doomed to disappointment.

Interview with Maria Bartiromo, CNBC TV
Looking back, although Buffett was right, he drastically underestimated the situation, because from the time he made that statement in 1999 until today, over ten years later, the major stock indexes are down 30% or more. While it is possible that Mr. Buffett could be wrong, history has certainly been on the side of those who have believed in him.
There are many other individuals with acknowledged expertise in investments as well as economists who believe that stock market returns in the future will be significantly less than they have been in the past. They offer several themes to support their conclusions:

WHY WILL THE MARKET'S GROWTH
LIKELY BE SLOWER IN THE FUTURE?

Despite market corrections in the major averages…the Dow Jones Industrial Average, the Standard & Poors® 500 Index and the NASDAQ…stocks are still selling at heftier prices now than even a historical midpoint of a range of values for these averages.

Bubbles previously created in the Internet, telecommunications and financial sectors through unprecedented access to the capital markets, resulted in unsustainable levels of borrowing and capital spending. This has been unwinding for some time as the bubbles burst and as deleveraging has occurred. Many believe that such bursting, reduced borrowing by both businesses and consumers and increased government borrowing have long-term implications that will slow future economic growth and affect other industries.

Corporate profits would have to grow at an abnormally high rate in the future as a percentage of Gross Domestic Product (national output) to support much higher stock prices. Since this is very unlikely, the relatively high level of current stock prices will increase more slowly as corporate earnings growth works to catch up and bring about more normal stock price averages in the future.

Interest rates are now at lows not seen since the Eisenhower Administration in the 1950s. Inflation is very low. Both of these factors are certainly strong supporters of relatively high stock prices. Yet to support significantly higher stock prices, both interest rates and inflation would need to decline even more. The problem is that there is no additional room for either to decline further.

These are the primary schools of thought regarding why stock prices are likely to grow at a slower pace in the future than they have in the past.
If this vision becomes reality, new paths will be needed for investors to have any hope of achieving double-digit investment returns. A simple strategy unknown to the vast majority of individual investors--put option writing--may present one of the best opportunities to achieve double-digit returns in this projected future.
Do you believe the market has bottomed, or is close to a bottom, but that going forward our average stock market returns will be significantly less than the boom years of the past? This is the best possible market environment for put option writing.

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