Options for Stockholders

One Conservative Option Strategy

businesspeople
Investing. Pixabay

If your preferred investment method is to own individual stocks based on fundamental analysis, then it is reasonable to assume that you conduct careful studies to find stocks that have performed -- and that you expect to continue to perform -- better than the market averages. After all, it is far easier to buy index funds that match the performance of "the market" and there is no reason to continue to buy stocks when your results underperform.

Advice: Maintain a list of stocks so that when one of them becomes especially attractive, or when you have additional cash to invest, you are prepared to make an intelligent decision fairly quickly.

If you believe in conducting technical analysis (the study and use of stock charts) rather than depending on the fundamentals of the underlying stocks, then maintain a list of stocks whose charts you check fairly often. When you find a satisfactory chart pattern, then go ahead and make your trade.

For anyone who buys stock, there is a sound alternative investment strategy: The sale of naked put options. 

Selling Naked Puts Instead of Buying Stock

Put selling earns profits far more often that outright stock buys. However, when stock prices surge, put seller's profits are limited to the cash premium collected. The problem is knowing what the future stock price will be. Investors who prefer to earn more frequent profits and who are willing to sacrifice the possible huge profit that is available when the stock price surges, are better served by selling puts than buying stock.

There are two basic ways to adopt this strategy when your goal is to buy shares of XYZ at a price of $40 per share or less when the current strike price is higher (i.e., $41 or $42). The following alternatives apply when your methods call for making an investment in XYZ. It is not a good idea for investors who conduct research to abandon that research just to make a randomly-timed put sale.

  • Sell any XYZ put whose strike price is $40. This guarantees that you do not pay more than $40 per share (assuming that you eventually buy stock). In addition, the premium received for selling the put reduces the purchase price (by the amount of that premium). This trade strategy comes with some warnings: Do not sell too many puts (sell one put for each 100 shares that you are willing to buy), and establish a minimum price for the option (selling options for a very small premium is a poor idea). For example, if you sell a 60-day option and collect $1, if the option expires worthless, you earn $100 but do not buy stock. This sounds like a good deal to me, especially when you consider this profit as a consolation payment for being unable to buy XYZ at your price.
  • Sell any XYZ put whose strike price is $40 -- as long as the premium is MORE THAN $5. Why more than $5? When you are eventually , you will pay $45 per share for the stock. That price is reduced by the premium -- so if you collect < $5, your purchase price will be >$40 (your target). 

Reminder: Option prices are affected by the implied volatility of the underlying stock. Thus, if you want to adopt this method for steady, high-dividend-paying stocks, the put premium will not be very high and that means your ultimate purchase price for the stock will not be much lower than $40.

More volatile stocks come with higher put premium, but, of course, these stocks are riskier to own.​ Choose your stocks carefully.