Imagine being able to pay whatever you want for your favorite stock. How would you like to be able to pick the purchase price with very little regard to where the shares are currently trading?
Sound too good to be true? Well, that’s what I thought when I first learned of this little-used method.
And believe it or not, it gets even better. If this tactic fails and you can’t get the shares at your price, you’ll get paid for trying.
The Market’s “Can’t-Lose” Strategy
There’s a reason why some people regularly win in the stock market. It’s not that these people are any smarter, cleverer, or even have access to better information. While these things can provide an edge over other investors, it’s often the knowledge and application of a few simple strategies separating the habitual winner from the masses of struggling investors.
One of these simple strategies employed by winning investors is only paying discounted prices for stocks.
Professional investors rarely pay market price for stocks.
I’m not talking about buying at the bid or any other type of short-term, computer-driven trading tactic.
This strategy is for long-term investors, and anyone can use it.
You may be thinking that this approach can only be used on rare occasions when then stock sets up in just the right way, but it can be used at any time with any stock.
The way professional investors pay what they want for the stock is by selling a put option (an option that gives the owner the right to sell a number of stocks at a specified price) at the price they want to pay for the shares (the “strike price”).
You get paid cash for the put option that you can keep regardless of whether or not the option is exercised (if the stocks are sold). If the shares never drop to your price, this income generated by selling puts can be a consistent source of monthly income for savvy investors.
In fact, there are many professional investors who earn a high return strictly by selling puts on upward trending stocks and indexes.
Isn’t It Dangerous To Sell Puts Or Even Trade Options?
Most people have heard horror stories about investors being wiped out in the derivatives market. The truth is, options can be very hazardous to your financial health if used incorrectly. However, the selling of puts has the same risk characteristics as the safest option strategy, the covered call.
As long as your plan is to purchase the shares at your lower chosen price, selling puts can be safely used by every stock market investor.
How To Do It
Sell one put option contract at your chosen strike price for every 100 shares of stock you wish to purchase at the discounted price. The further away from the put’s expiration and the closer the strike price to the current share price, the greater the premium you will earn. However, these characteristics also signify a greater the chance of your being required to purchase the shares and reduce the share price discount available.
What To Expect
Only two things can happen when you sell a put.
The first thing is that the stock price fails to drop to your chosen price before the expiration date. If this happens, you retain the premium earned for selling the put. This strategy is used by wealthy investors to obtain a continuous income stream from the stock market without owning shares.
The second is that the share price falls to the strike price of the put or below by the date specified. In this case, you will be obligated to buy 100 shares for every put sold.
Because purchasing the shares at the lower, discounted price was the original goal, this result is welcomed and not a surprise.
Buying the shares at the lower price has a two-fold benefit. Not only can you buy the stock at the value price you pre-determined, but the premium received by selling the shares remains yours to keep. This effectively reduces the amount paid for the shares.
For example, imagine you wanted to buy 100 shares of a stock at a strike price of $5. You sell the appropriate put for these shares for $50. When the expiration date rolls around, your chosen stock is trading at or below your $5 price. This means you’ll need to spend $500 to buy the shares.
However, because you’ve already made $50 selling the put, the cost to you is effectively $450, meaning you’ve really paid only $4.50 per share.
Risks To Consider: The primary risk is not being prepared to purchase the shares should the stock price fall to or below the strike price. Selling naked puts without the intention of buying the shares is a tactic reserved for only the most sophisticated investors and can be devastating to inexperienced traders.
Action To Take: Use a demo account to practice actual trades you’d want to make, before you dip into your real money account, to learn how the process works on your trading platform.
— David Goodboy
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Source: Street Authority