How to buy stocks with cash-secured puts
You may already know that you can exercise an in-the-money call option to purchase shares of the underlying stock at a discount to the current market price. However, there's an alternative method you can use to acquire stock with options -- and it's actually more beneficial to your bottom line. It's known as the cash-secured put, and it lets you get "paid to wait" to buy shares on a dip.
The method is simple. Let's say you're bullish on XYZ, and you'd like to add 100 shares to your portfolio. However, the stock just tagged a new annual high of $57, and you'd prefer to buy on a pullback to previous support in the $50 neighborhood.
Of course, you could always play it straight by simply waiting for this pullback to play out, and then placing an order with your broker to buy 100 shares once XYZ hits $50. Assuming the trade executed at your preferred entry price, you would pay $5,000 for the stake (100 shares at $50 each).
Alternately, you could use the cash-secured put strategy to lower your cost basis. To do so, you'd sell to open one put option for every 100 shares you'd like to acquire. The strike price should align with your desired entry price of $50.
At the same time, you'd deposit into your brokerage account a sufficient amount of capital to cover all of your liability on these short puts. This would amount to $5,000, since you're accepting the obligation to buy 100 shares per contract at the strike price of $50, should those puts go in the money prior to expiration.
However, since you also sold a put option, you've lowered your effective entry price on the stock position. Let's say you sold a put with three months until expiration to allow plenty of time for the expected pullback to play out. The puts are being offered at $0.75 each, which -- multiplied by 100 shares per contract -- amounts to a premium of $75 on the option.
There are a few potential outcomes when you sell a cash-secured put in this manner. If XYZ remains at or above $50 through expiration, the put will expire worthless. You won't be assigned on your option -- meaning you won't have the opportunity to buy the stock at your preferred entry price -- but you'll be able to retain the $75 premium as your profit on the play.
On the other hand, if XYZ finishes below $50 at expiration, you'll likely be assigned. This means you'll be on the hook to buy 100 shares per contract at the strike price of $50. After accounting for your $0.75 premium payment on the sold put, your effective entry price on the stock is $49.25. Assuming XYZ bounces from support and resumes its uptrend, you've been paid to wait to buy a stock you like on a pullback -- not a bad deal at all.
Of course, it's also possible that XYZ could keep falling below the strike price, and you might get stuck buying the shares as they embark on a deeper slide. This is a risk worth considering whenever you enter a long stock position. All things considered, however, using cash-secured puts to buy stock offers some clear advantages over the traditional buy-on-the-dip methodology.