|
This is a level 2 question.
I've heard that instead of using a limit order, you can sell puts to acquire a stock at a specified price. Can you describe how to use options to do this?
An investor can sell a cash-secured put as a way to purchase a stock he wants to own at a specified price. This strategy is similar to issuing a limit order for a stock, but it allows the trader to collect a premium for the put, which will further reduce the breakeven point for the trade.
For example, assume that an investor would like to own Yahoo! (YHOO), but he would prefer to acquire the shares at 20 rather than at the current market price of 23.50. To execute a cash-secured put, he would sell a front-month 20 put and deposit $2,000 in an account with his brokerage firm to cover the purchase of the shares if the option is exercised.
If YHOO falls below 20 at expiration, the option will be exercised, and the investor acquires 100 shares of YHOO at his desired price. Assuming he sold the put for 1.50, for example, his breakeven for the trade would be 18.50. If the stock does not fall below 20 at expiration, the option expires worthless, but the investor retains the premium he received for the sale of the put.
Instead of selling an out-of-the-money put, the investor could sell an at-the-money or slightly in-the-money put that brings a high enough premium to lower the breakeven on the trade to an acceptable level. For example, if the investor believes that YHOO would be a good value at 22, he could sell a January 25 put, which is bid at 3.00. By selling an in-the-money put, he increases his chances of being assigned, especially as expiration approaches. The 3.00 received for the sale of the put would lower his break-even point to 22, which is his desired acquisition price.
You should be aware that in either of these example, if YHOO declines substantially, the investor would still have the obligation to buy the shares at the strike price of the sold put, even if the shares have fallen well below the put strike. This strategy also doesn't protect you from further losses once you own the shares. However, it can be an effective way to acquire a stock you want to own at a specified price while lowering the breakeven on the trade.
Thanks for your question and good luck with your options trades.
|
Question Level Key
Level One--Basic Jargon, Definitions, Basic Mechanics of Trading.
Level Two--Introductory Points, Practical Points and Simple Strategies
Level Three--More Advanced Strategies and Repairs
Level Four--Risk Management, Psychology, and How Best to Evaluate Things.
Level Five--High end questions concerning Portfolio Analysis, Managing a Portfolio
of Options, Option Pricing Models, and Nuances of Trading. Included could be a variety of
other topics.
|
Do you have questions about options trading?
We've got answers.The idea here is that you submit any questions you have
regarding options trading, and each trading day we will select one question to answer from
all those submitted. Then, we'll archive each question we answer so that over time,
the Q&A Archive will grow into an extensive library of educational material.
The key component to this equation is that we need your questions. They can be as
simple or as complex as you like, and we will try to answer a fair sampling on both ends
of that spectrum.
|
Today's Most Popular Stories
Read
Emailed
Editor's Pick
|
