The following is an excerpt from James Altucher's Internet Review newsletter, originally sent to subscribers on March 27 at 9:52 a.m. EST. For more information on this newsletter and for a free trial, click here.This week I'd like to revisit a strategy I consider very effective when investing in value stocks (I consider most of the stocks in the Internet Review portfolio value stocks in a growth industry -- the best of both worlds). We're in many of the stocks in the Internet Review for the long haul. But wouldn't it be nice to generate some income on them in the meantime? We can do that by selling put options on select positions. If the stock price falls below the options' strike price, you get "put" more shares (meaning you're obligated to purchase them), but at attractively low prices. That's not a bad proposition, because we like these stocks, right? And if the underlying shares rise, we still get a "paycheck" from selling the options! This strategy is related to portfolio construction. When I initially enter a position, I only make it 1% to 2% of overall holdings, because I'm not a believer in the focused portfolio idea of having, let's say, only 10 picks. I prefer 30 to 50 picks because, as already demonstrated by our current portfolio, one can significantly outperform the market. I do leave room to increase the size of individual positions, usually to around 3% of total holdings, and I accomplish this through the put sales. The nice thing about these sales is that even if the puts expire worthless and I don't increase my stock positions, I still get a nice options premium and reduce my cost basis. Below I discuss the stocks I highlighted in my Feb. 27 newsletter as being candidates for put sales, describing what actually happened. I then discuss where I would now sell puts for April expiration. Copart ( CPRT): I suggested the March $25 puts, which were trading at 15 cents. The stock closed at $26.86 last Friday; the $25 puts would have expired worthless. You would have made $15 on each contract you sold (one contract is for puts on 100 shares). Right now the stock is at $27.49, and it doesn't look like there are any interesting (i.e., cheap) contracts to sell.
iPass ( IPAS): I liked the $7.50 puts for 80 cents or more. Last Friday the stock was at $7.43. The puts never reached 80 cents, but just to give you a sense of how this works, even if you had sold them for 45 cents you would have made money. The puts did not expire worthless so the stock would have been put to you at $7.50. You would have lost 7 cents on the stock but made 45 cents on each share from the original sale of the puts. The net gain would be 38 cents, or about 5%, in less than four weeks. The stock right now is at $7.38, and I believe selling the April $7.50 puts for 55 cents or more would be a good trade. Microsoft ( MSFT): I saw an opportunity to sell the $27.50 puts for $1.50 or more. The stock closed March 17 at exactly $27.50, so the puts would've expired worthless, netting you the income from the sale. Right now, with the stock at $27.01, none of the puts looks cheap enough for me, particularly given the recent volatile news on Microsoft. For example, the April $27.50s last traded at 60 cents. If the stock is still at $27.01 on option-expiration day, then you only net 11 cents per share, minus the commissions. This simply is not worth it. At this price I'd be interested in Microsoft $27.50s at $1.25 or more. KongZhong ( KONG): I wanted to sell the $12.50 puts "all day long." This would have been a huge win because the stock closed March 17 at $12.28. So the stock would be put to you at $12.50 and you would lose 22 cents. But you made $1.20 on the puts, netting you 98 cents, a gain of about 8%, in less than four weeks. Right now KongZhong is at $12.15, and the April $12.50 puts are trading at 75 cents. I think 75 cents is not enough to take on the risk of owning KongZhong for less than $11.75. However, if the puts hit $1 or more, I'm interested.
Marchex ( MCHX): The $22.50s looked good at $1, but no cheaper. Shares closed March 17 at $21.16, so this play would have lost you money, but it's equivalent to having averaged down on Marchex at $21.50 ($22.50 minus the $1 premium). With this company's 100% year-over-year growth and great business model, I'm happy owning more shares here. Time Warner ( TWX): I liked the sale of the $17.00s for 20 cents, a lot! TWX closed at $17.07 on March 17, so the puts would have expired worthless, and you would have pocketed 20 cents a share. Right now you can sell the $17.00 puts for 30 cents. This is a good move, because I wouldn't mind adding to my Time Warner position at an effective price of $16.70 a share. In fact, I've sold these exact puts in my own portfolio for 25 cents. Yahoo! ( YHOO): Selling the $32.50 for 60 cents carried some risk, but it seemed worthwhile. Since Yahoo! closed at $29.83 on March 17 you would have effectively averaged down at $31.90 if you sold the $32.50 puts for 60 cents. Right now I like the April $32.50 puts for $1.65, but since we just averaged down and Yahoo! has bounced sharply off of its lows in the past week, I believe it's wise to wait for a better price. This put selling accomplishes two things. We make a little extra money on some of our positions, effectively reducing our cost basis, and we get paid to average down on stocks we like at prices we consider cheap. Not a bad deal, huh? Here are some more stocks in the portfolio I would consider selling puts against: NetEase.com ( NTES): This stock has had a very quick run to $90.00, and I would sell the April $85.00 puts for $1.65. I would also sell the $100 calls for $1.10. If these get hit (meaning if NetEase.com goes as high as $101.10 and our shares get called) we will be happy campers, because we'll take nice profits after pocketing the call premiums.
Tom Online ( TOMO): The April $20.00 puts look good at 40 cents. Right now shares are at $22.25. If the stock remains there, we collect our 40 cents, giving us almost a 2% gain in less than three weeks. If the stock goes down to $19.80, I'm happy adding to my position there. InfoSpace ( INSP): This stock has been in the portfolio for only two weeks, but it has had a nice move -- jumping 8.5% vs. 1.8% for the Nasdaq. However, with the stock now at $27.00, I don't mind selling the $25.00 puts for 40 cents each. That's because $24.60 (lower than our current cost basis) is a cheap price to pay for this stock. United Online ( UNTD): I would definitely sell the April $12.50s where they last traded, at 40 cents. This stock is beyond dirt cheap at this point, and I wouldn't be surprised if we quickly see it top $14.00. Crazy? I'm "put crazy," you say? Not always. Here's an example where I wouldn't sell them. E*Trade ( ET) is at $25.85 right now and the $25.00 puts are trading at 35 cents. So if we were to sell them, and if the stock were to sit right here at $25.85, then we would make about 1.6% when the puts expire. That's not enough of a gain for me, particularly considering that E*Trade started the year at $20.00, significantly lower than where it now trades. It's just not worth the risk. Nor do I consider E*Trade particularly cheap here, although it's not yet at the level where I would want to sell the position, either. I just don't feel like averaging down at these levels. For more information on this newsletter and for a free trial, click here.