In my previous post, I discussed how stock options can help protect investors from the uncertainty of the stock market.  We reviewed the basic types of stock options, and how owning puts gives stock investors peace of mind knowing that no matter where the stock opened each morning, the put guaranteed that the stock could be sold at a given price (the strike price).  In this post, I will review another special strategy that is not available to the ‘pure’ stock investor, but should be of interest as it allows him/her to buy their stocks at a discount.

Firstly, it is important to recognize that this strategy is only to be considered by stock investors who are long-term bullish on a particular stock and plan to buy it.  The obvious consideration then is – if one is going to buy the stock anyway, one would like to buy it cheap (pay the lowest amount one can).  After all, why pay ‘full price’ if one can get a discount?

Secondly, both markets and individual stocks go ‘up and down’ all the time.  Many stock investors evaluate the fundamentals of a stock they wish to buy, and buy stocks with good fundamentals when a temporary market down-turn pushes a stock price down.  This has been called ‘buying the dips’ – the expectation, of course, is that when the market turns up again, stocks with good fundamentals will rise.   While this is a good strategy to accumulate stock over a period of time, options trading offers a better way to not only buy such stocks at a discount, but also earn money for the opportunity to buy the stock at a discount.    

HOW TO BUY STOCKS AT A DISCOUNT – SELLING PUTS

To implement this strategy, one will need to have money in the account to cover the purchase of the stock.  Also, since selling puts is generally considered risky, one will have to obtain clearance from the broker to do this trade.  Let’s review some basic concepts about stock options that we discussed last time …

i.     There are two main types of stock options – calls and puts. 

ii.   Buying gives you ‘rights’, selling gives you ‘obligations’

iii.When you buy something (either a call or put), you pay a price (called the ‘premium’)

iv.  When you sell something (in this case a put), you receive the premium

v.    The obligation you take on when you sell a put is that you will buy the stock at the strike price if the stock is ‘put’ to you (called ‘assignment’)

Since the stock investor aims to buy the stock anyway, having the stock assigned is not a problem.  This strategy is called ‘cash-secured put selling’.  Let’s consider an example (data on 1/27/2014).

AAPL Feb 2014 stock options

AAPL March 2014 stock options

The graphic above depicts the February 2014 and March 2014 option chains of Apple (AAPL) on Monday 1/27/14 (prior to AAPL earnings announcement after the close). If one sold the 500 put, one would take on the obligation to buy AAPL at the price of $500 should the stock be assigned on expiration day.  For taking on this obligation, one would be paid the premium of $3.40 per contract (Feb 14) or $6.45 per contract (March 14), which would equate to $340 and $645 respectively for each 100 shares.  As noted, AAPL is currently at $552 per share; if AAPL was below $500 per share, the stock investor will buy the stock for $52 less than what he/she would pay now.  In essence, he/she would get to buy the stock at a 9.4% discount to current stock prices, and be paid for the opportunity to do so.     

Caveat Emptor! As mentioned earlier, this options trading strategy should only be implemented by those with a long-term bullish outlook on the stock and seeking to accumulate the stock.  Until next time … 

Happy Trading!

If you currently trade both stocks and stock options –

Do you use cash-secured put selling to buy your stocks? If so, please share an example when it allowed you to buy stock as a substantial discount. 

If you only trade stocks –

You may wish to use the above strategy to enhance the performance of your stock portfolio.  Of course, this strategy can only work for stocks that have options