When the timing is right, options traders can purchase stocks at a discounted price. But how do they go about it? They simply sell put options on the stocks they aim to own and wait for the price to drop.  Once you understand the basics, things will start flowing easily. With the following tips, you can readily buy stocks at a discount.

Identify the Stock You’d Love to Own

When looking for a quick way to buy stocks by selling put options, you ought to start by identifying the stock you’d like to own. Remember, you’re seeking to incorporate the stock you purchase into your existing portfolio. So, you shouldn’t just pick any old stock when trying to implement this strategy. This may seem obvious to you but it does play an important role.

Sell Put Options

The next step is to identify the put option you’re going to sell. As an option seller, there are three options to choose from; at-the-money options, in-the-money option, an out-of-the-money option. Typically, when selling puts to purchase stocks, you’re going to utilize an at-the-money put option. This strategy offers an incredible balance between paying a considerable amount of premium and offering you the perfect chance of having the desired stock put on you.

It’s also important to note that the premium you get for selling the put option will directly impact on the discount you’ll receive on your stock purchase in case the stock is put on you. And the higher the amount of premium, the greater your discount will be. Certain stocks offer high premiums on their put options since they’re extremely volatile or because everyone believes that the stock will be moving slower. If you don’t do your research well, you might be tempted to go for a stock with the highest premium.

Manage Your Trade Wisely

After selling your put option, it’s time to wait and see how the stock price changes. One of the following things could happen:

  • The stock price can increase significantly

  • The stock price can increase slightly

  • The stock price can drop slightly

  • The stock price can drop significantly

If the stock price increases significantly after selling your at-the-money put option, don’t do anything. This is because the put option you sold will expire worthlessly, and you’ll keep the premium you got when you sold the put.  And if the stock price increases slightly after selling your at-the-money put option, the put you sold will probably expire worthless or with very little intrinsic value. Both outcomes make it possible for you to retain the premium you received after selling the put.

When the price drops slightly, the person to whom you sold the put might choose to exercise the option, meaning that you’ll have to purchase the stock at the strike price defined by the option. If you finally decide not to purchase the stock, you can always repurchase the put you sold and leave the trade.

Different Strategies for Utilizing Put Options

Equity traders who strive to minimize the risk of shorting stocks usually turn to put options as a means of mitigating risk, creating more precise trading techniques, or making speculative bets on the stock downside. Here are five basic put option strategies you should seriously consider.

The Long Put Technique

The long put strategy is one of the most basic put option trading techniques. It involves purchasing put options as bet which the underlying stock will reject below the option’s strike price before its expiration date. This approach caps the potential risk at 100%.

Bear Put Spread

Traders using a bear put spread strategy buy put options at a particular strike price and expiry date whilst simultaneously selling the same put options at the same date at a reduced strike price.  Therefore, the total cost of the bearish bet is cut down by the profits generated from selling the put options. Potential profits are typically capped once the stock price falls below the sold put’s strike price.

Bull Put Spread

This strategy involves buying put options at a lower strike price while concurrently selling the same put options at a higher strike rate. Once you initiate the trade, the puts that were sold at a higher strike price will start generating more income than those bought at the lower strike price. If the underlying stock trades at a greater price than the sold put’s strike price, the sold puts will expire worthlessly and you retain the profits from the sale. And if the stock trades lower, the purchased puts mitigate the downside risk.

Protective Put Option

Protective put option strategy offers an incredible way for traders to protect themselves when a downturn occurs on a stock they already own. Purchasing a cheap put option for this type of stock means that you’re essentially purchasing an insurance cover on your long position. If the stock rises as expected, you probably won't need this insurance policy. But since the protective put tends to profit when the stock falls, it can offer a good hedge. And this is an extremely attractive feature, especially when it comes to options trading.

Long Put Butterfly

Already have a target price for a given stock or a specific date for trade-in mind? Well, the long put butterfly approach can be a nice option for you. It provides an incredible way to utilize put options for making big bets on specific stocks at a relatively cheaper cost. All you need is to sell two put options featuring the same strike price as your target stock price.

Final Thoughts

Selling put options is an extremely flexible and powerful tool for generating income as well as entering stock positions. Instead of purchasing shares at whatever price the market currently offers, consider calculating exactly what you are willing to pay, and then sell your put option to get paid for the period you’ll wait until it hits that level. Sounds great, right? It’s as simple as that!

 

Published by Lavismichel Inkel