Yesterday, I wrote about selling a call option if you had a bearish outlook on a stock. Today, I will talk about selling a put if you have a bullish outlook on a stock.
If you sell a put, you are giving the buyer the right to sell you a specific stock at a specific price (strike price) on a specific date or range of dates (European and American style options respectively). You collect a premium.
If the stock goes up or stays the same in price, the buyer has no incentive to exercise his option of selling to you at a lower price.
If the stock goes down in price you will begin to lose your premium. If it goes down more than your premium, you lose your own capital. Your maximum loss is if the stock goes to zero. The buyer of your put could sell it to you at the strike price and you would have to pay for a stock that was worth nothing
So, the two bullish (positive) strategies I have mentioned are buying a call or selling a put. The two bearish strategies I have mentioned are buying a put or selling a call.
Unless I get further questions on options, I will probably leave the topic for now.
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Addressing the two bearish strategies you have mentioned (buying with put options, selling with call options), I have a couple of questions, as well as a couple of additional comments:
First of all, buying a put, someone PAYS you good money to buy a bargain priced stock -- is that right? That sounds just too good to be true! What is wrong? Hidden deep inside this meal ticket must be a dark lining. Hasn't it been proven over and over again that it is far more profitable, if you really want to buy the stock, to buy it at the market? I'm assuming that you really want to buy the stock, and don't want to miss the boat by trying to bottom-feed. If you have carefully waited months for the RIGHT TIME to buy stocks and it has finally arrived, shouldn't you just buy the stock and not screw around trying to get the last bottom penny out of your trade? Also, buying a put requires me to commit myself to buy at minimum a hundred shares per contract. So, in most cases, if I acquire a stock via put options, I could be investing $5,000 for a $50 stock, and $9,000 for a $90 stock. Because an option is ALWAYS for 100 shares of stock, that's just TOO MUCH of an investment for me to manage, especially if I am managing my positions using dollar-cost-averaging rules. Of course, there are $20 stocks with options available that will fit more into my plans. The other consideration requires that I have enough cash (or margin) available to buy the stocks that I want to buy at market. But the BIGGEST DISADVANTAGE to buying with put options is that I may not get the stock that I really want to buy. I might be forced to keep all of that money which they paid me, whether I wanted it or not! Don't laugh at me: I really wanted the stock instead of the money, durn it!
Second of all, selling a covered call option, you are also paid CASH up front that is yours to spend no matter what may or may not happen. And the longer the call option contract is that you sell, up to nine months out, the more money you get paid for it. Or you can sell a contract on your 100 shares of stock that can expire in a month or less. In other words, you are in total control. If the stock goes up and your option expires with the stock higher than the strike price of the option, your option will be exercised, and you will be paid the strike price of the option for your stock. Since you were also paid the option premium up front, you have made money and are a winner. If the stock stays at the strike price of the option or goes down, your option expires worthless and you keep the money you were paid up front for selling the option and you also keep your stock. Now you can write ANOTHER option, and try again to sell your stock (and get paid again for another option). After all, you are selling your stock with call options in the first place because the stock has turned into a real dog. It's no longer a growth stock and you are wise to weed it out of your portfolio. Or its PE multiple is way out of sight, or you just want out, for whatever reason. Perhaps you are just sick of looking at it sit there like a dead sphinx. If the stock stays at the option strike price or goes down, your option's daily trading price will slowly follow suit down, and you might decide to buy your option back at a MUCH lower strike price. The difference between the price at which you initially sold the option, and the price at which you pay to buy it back is your profit. Being free of that old contract, you could then write another option for TOP dollar. So it appears to me that you could/should sometimes/frequently make more money selling covered call options against a stock than you might profit by trading the stock itself! In either situation, the option writer appears to be the clear winner. He gets EXACTLY what he has contracted for. His risk is low. (Even if the underlying stock unexpectedly rockets up by 300%, the option writer does NOT lose: Potential profit missed is NOT a loss. Besides, most option writers would appear to already have a substantial profit on their stock. If their stock is taken away, their profit is locked in with cash. In addition, they end up with more money than if they had just called their broker to sell their stock. The trick, I suppose, is to KEEP the stock, and get CALL MONEY too. But that goal is admittedly GREEDY. If your main strategy is to place your money into growth stocks, not to write (or trade) options, then selling a covered call is simply a tool to sell a stock that you no longer want to own. Nothing more, nothing less.
There are dozens of other fancy and complex option strategies which I have heard or read about: Xmas trees, butterflies, buy/write programs, ratio/write programs, etc., etc. I will have none of them. I have not used them because I either don't understand them or I don't like the numbers required to make them viable. I only like limited risk/maximum gain strategies. There are many strategies being touted that are clearly limited gain and maximum risk (such as the buy/write programs which I mentioned above). The only strategy that I enjoy using options for is to either BUY STOCK at a bargain price (put option) or SELL STOCK at an inflated price (call option).
Posted by: Bob Hansell | February 11, 2006 5:00 PM | Permalink to Comment