Daniel is a retired business executive who now devotes most of his free time to trading stocks and stock options in the stock market.
Make Money While Waiting!
How often have we heard someone say "I would like to buy that stock but I’ll wait for the price to drop before I get in."
Did you know that you could actually make money while you are waiting for the stock to drop to the lower price level?
And if it never drops to that lower level, so what? You’ve made money while you were waiting!
Here’s a real scenario that actually unfolded when I wrote this piece. Roku Inc, a company primarily operating a TV streaming system, had its Initial Stock Offering (IPO) on Wednesday, September 27, 2017, at an initial offering price of $14 per share.
The following day, Thursday, the stock began trading on the NASDAQ exchange at an opening price of $15.80, going to a high of $23.50, dropping to a low of $15.75, going up again and closing the day at $23.50. In the following days, the stock continued see-sawing up and down.
On October 20 a friend of mine, let’s call him James for this article, who is an active stock market trader/investor, mentioned to me that the stock had gone down to the level of $20.86. He told me he was watching the stock closely and would buy into it if it went down to the price of $18.
The stock had maintained its price level above $20 and it looked like it would probably go into a trading pattern at around the mid $20’s for some time.
Unfortunately for my friend, James is not well educated in the wisdom of using options as a tool to significantly expand his opportunities in his stock trading activities. He could have in fact gotten into ROKU stock immediately by selling ROKU put options while waiting for the price to come down to his desired level and in so doing generate some revenue in the process. How does he do this?
James is a buy-and-hold stock investor so he doesn’t mind waiting patiently for a stock price to come down to his desired level since he intends to hold it for future price appreciation. He is, in effect, a market timer. He plays stock market timings as they go up and down. If he were knowledgeable in options he could play the market either up or down without having to wait for the right time to get in or out of any stock that he fancies. He sells options when he is waiting for a down market and sells his assigned stocks if/when the market goes up.
Looking at the ROKU option chain table below listing options expiring in January 2018, he could have sold the strike 18 put options at a price of $1.10-$1.50. For this exercise let us assume he was able to sell the option at the midpoint price of $1.30.
You must know by now, if you have been reading about how options operate, a put seller like James places himself in a position where he is obligated to buy the stock if the price dropped down to the price level he desired, in this case, $18 or below, on or before the expiration date.
The process whereby a put seller is compelled to accept delivery of the stock is called assignment. The put option holder (buyer) is assigning his stocks to the put option seller (James) and the latter is obligated to buy the stocks assigned to him. In this case, James must pay the price of $18 per share. If this should happen James would be more than happy to pay such price since it was his target price from the beginning. In essence, he is actually buying the stock at a big discount.
Further down this article is another example of buying a stock at a discount.
Generating Cash Revenue
If James had sold the January 18 put option at $1.30 he immediately would have taken in this amount in cash and this would have been immediately credited to his broker account.
Assuming James had originally set aside the amount of $10,000 to purchase ROKU stock at $18 per share, this would have enabled him to buy 555 shares with his $10,000. Options are traded in lots of 100 shares per contract so in this instance he would have been able to trade 5 contracts (500 shares) of the January 18 puts. At $1.30 he would have generated a total income of $650 from this put sale. His broker account would have now shown a total cash balance of $10,650.
The choice of options expiration month is entirely the personal preference of the seller in accordance with his investment goals. James could have selected a longer expiration and taken in more money like selling the April 18 put options instead of January 18’s for as much as $2.45. This would have given him a total revenue of $1,225.
Now all that James needed to do was sit and wait for the outcome of his action.
If on the third Friday of January 2018 (equity options expire on the 3rd Friday of each month) ROKU’s price stayed higher than $18 James would not be assigned the stock, i.e., not be obligated to purchase the stock. It matters not for him since he made a clean profit of $650 by just waiting. He just earned $650 on his $10,000 cash parked in his broker account. That’s a 6.5 percent return on his dormant cash.
If James was a pure market timer without knowledge of options he would have waited for the price to drop to $18, and would still be waiting for the price to come down to his level. In the meantime, his cash account would not be earning any money during this waiting period.
Can you think of any place where you can park your cash and make a 6.5 percent return in just 90 days? All this is assuming that ROKU’s price had remained above $18 per share all the way to January. James made himself a profit of $650 by just waiting without owning ROKU stock.
Buying Stock At a Discounted Price
How do you buy shares of stock at a discounted price? In the ROKU setting described above, James would have been assigned (bought) the stock at $18 if the stock was at this price or lower on expiration date in January. Less the $1.30 he already received from the sale of the put option gives him a discounted net cost of $16.70 for the ROKU stock.
As stock market timings go, James’ wait would have enabled him to buy the stock at $18 when the price dropped to this level. His 90 day wait for the stock to drop did not give him any benefit except buy the stock at the price of $18. Whereas, by selling puts in October his wait yielded him some revenue which in effect resulted in a discounted price of $16.70 for the ROKU stock.
Here is another example of how to sell options as a method of discounting the price of the desired stock.
As I wrote this piece The Walt Disney Co. (DIS) was trading at $98.55. Instead of buying the stock at this price you could sell the December 97.5 put option at $3.00. If the stock continued to fall down to the level of 97 or 96 or any price below 97.5 the option would be assigned and you would have to buy the stock at 97.50. But since you received $3.00 from the sale of the put option your net cost is really $94.50.
You just bought DIS stock at a discounted price of $94.50.
Any and all information pertaining to trading stocks and options including examples using actual securities and price data are strictly for illustrative and educational purposes only and should not be construed as complete, precise or current. The writer is not a stockbroker or financial advisor and as such does not endorse, recommend or solicit to buy or sell securities. Consult the appropriate professional advisor for more complete and current information.
This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.
© 2018 Daniel Mollat
Richard Jones on May 28, 2020:
David on October 27, 2018:
Very easy to read. Thank you.