Free 7-day Trial
All Articles and Columns »

A Cost-Effective Way to Nab a Stock - Barrons

September 15, 2009



By STEVEN M. SEARS - Barrons.com

Selling a put to lower the cost of buying stock can add another dimension to investing.



Writing put options puts odds in your favor that a Las Vegas gambler would die for. If the stock goes up you win, if the stock stays the same you win and if the stock does not go down more than the premium you collect you win a discount price. Used with high quality stocks this strategy is the only way to add positions to your portfolio.

THE CHALLENGE TO INVESTING is finding stocks just before their prices surge higher. Yet, most investors find themselves chasing stocks that have already advanced and hoping that the equities still have some upside juice.

Replace the hope, which has no place in investing, with a review of associated puts and calls on a stock, and investors may be able to super-charge a stock that already has made a nice jump in response to some news morsel.

Consider Federal Express (ticker: FDX), which recently told investors that they should expect better fiscal first-quarter results. Federal Express now expects earnings of 58 cents per diluted share, well above previous guidance of 30 cents to 45 cents.

The shares have advanced in recent days, and the news has been widely interpreted as an indication that the U.S., and global economies are improving.

The courier reports actual earnings on Thursday.

The key to confronting this stock, and it works for every share, is to think multi-dimensionally. Most people just think of stocks when they think of companies, and they miss the opportunity to benefit from information and securities in other markets.

We call this type of thinking the third-dimension of investing, and believe it be a critical lesson of the Credit Crisis in how investors should navigate the financial markets.

Third-dimension investors look at equity options on favored stocks for opportunities to increase returns, and limit risks.

For Federal Express, the January $75 put was recently priced at $5.30. Michael Schwartz, Oppenheimer & Co.'s chief options strategist likes selling the put -- a very bullish strategy -- to lower the cost of buying a stock whose price has increased more than 105% in the past six months.

By selling the put, investors lower the purchase price of the stock to $69.70. At the time Schwartz modeled the trade, the stock was at $77.32 and its purchase price is lowered by the amount of money received from selling the put. (Of course, prices are affected by transaction commissions so adjust accordingly.)

If Federal Express's pending earnings report further increases the stock price, the put will serve as an equity kicker. If the stock price declines, you potentially buy the stock at a discount.

"Rather than looking at the market and hoping for gains, say "put it to me!' Another way to look at the put sale is as a surrogate for the Good Till Cancel order type," Schwartz says.

A Good Till Cancel order entails instructing your broker that you are willing to buy a stock, at a certain price. The GTC order remains in force until the stock is bought at your specified price, or until you tell your broker to cancel the order.

When you absolutely, positively, have to own the stock, the put-write strategy makes a lot of sense.


Rating: 3.0/5 (3 votes)

Comments

bearuo
Bearuo - 4 years ago
Yes, there is reason to selling options to "lower the cost" of a stock. However, this lower cost comes with reduced flexibility and is not free. Short puts and GTC orders seem equivalent, but they are not. A GTC order can be cancelled quickly at no cost. Transaction costs to close a short put to pursue better opportunities, especially in the event of a crash when the spreads widen tremendously, can be prohibitive. Make sure to link your GTC orders with an index conditional, say the S&P, to avoid buying in the "early stages" of a crash.


The decision to be net long/short options should be based on implied volatility, not on whether one is bullish or bearish.

A lot is written about options except dealing with bid/ask spreads. Option ideas will excite your mind and those dollar a contract commissions will tempt you. However, it's the bid/ask slippage you must look out for. At a minimum, use Volatility Orders that automatically track the underlying ... IMO, the absolute best executions for individuals, especially on multilegged orders come from IB's trading desk which has reduced their minimum order size significantly.

When you absolutely, positively, have to own a stock, just buy it. There is nothing wrong with selling naked puts and Docx put-write strategy certainly makes a lot of sense in some situations. Just make sure you understand the "price" you are paying for that "lower-cost" of owning/potentially owning a stock.

Please leave your comment:


Get WordPress Plugins for easy affiliate links on Stock Tickers and Guru Names | Earn affiliate commissions by embedding GuruFocus Charts
GuruFocus Affiliate Program: Earn up to $400 per referral. ( Learn More)
Free 7-day Trial
FEEDBACK
Hide