Using Put Options to buy stocks

by admin

From time to time you find yourself in the position of an investor that has documented a stock , would like to purchase it yet the price isn’t quite there yet and you would love to buy it a little cheaper.

One of the best ways to acquire a stock is by using options, with options you can BE PAYED for purchasing a stock at a lower price then the market price (and that’s the worst case scenario ).

What is an option

An option is a contract which gives the buyer (the owner or holder of the option) the right, but not the obligation, to buy or sell an underlying asset or instrument at a specified strike price prior to or on a specified date, depending on the form of the option.

In the case of selling a PUT option you take on the obligation to buy 100 stocks at the price you choose if the market goes lower than the chosen price. For this you receive a fee.

How does this strategy work

Let’s take a clear cut example. I was looking into buying Dropbox (DBX) . I like the company’s product, the prospects look good for the next 2-5 years so I decided I would take a chance.

The price of the stock was 20.48$ , 100 shares would have cost me 2048$ . So instead of buying the stock, since the price seemed a little high, I decided to sell a put option at 19.5$ for October 2 (44 days away) .

For this contract I received 82$.

What are the possible scenarios
  1. The stock goes higher by October 2 and I collect the 82$ premium.
  2. The stock stays at the same price by October 2, I collect the 82$ premium and I can open again a similar trade.
  3. The price goes lower by October 2. In this case I have the obligation to buy 100 shares of the stock at 19.5$.

But remember, when I was first interested in buying the stock it would have cost me 2048$. So let’s assume the price of the stock by October 2 will be 18$ per share . In this case I would pay 1950$ for the 100 shares of the contract, minus 82$ that I already received as a premium. Making the total cost for a 100 shares 1868$.

Significantly better then the original 2048$ I was initially willing to buy at.

In conclusion:

You can use this strategy as a steady stream of “dividend” income . In 2 out of 3 cases you receive a premium for the risk you take. In the third you get to own the stock you already wanted at a lower price.

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