Writing Puts to Purchase Stocks

If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount.

So, instead of entering a limit order to purchase the stock, you can write an equivalent amount of near-month slightly out-of-the-money naked puts with a strike price that is equal to the target price at which you wish to purchase the underlying stock.

Thereafter, on expiration date, if the stock price and your sentiments towards the underlying stock remains unchanged, the puts that you sold will expire worthless. This lets you pocket the premiums received and write some more put options.

Should the stock price take a dive and goes below the put strike price, you can either follow through with your obligation and pickup the stock or you can buy back the put options at a loss. The decision you make will depend on whether your outlook towards the underlying stock has changed since taking up the position.

You should probably buy back the put options at a loss if a significant piece of bad news had surfaced which negatively impacted the fundamentals of the underlying stock, causing you to be no longer bullish on the stock. The premiums that you received should help to cushion some of the losses.

Otherwise, if the drop in stock price is minor and your target price is hit, you will be able to buy the stock at a reasonable discount along with the extra premiums received from the sale of the put options.

More Articles

  1. Investing in Growth Stocks using LEAPS®
  2. Day Trading using Options
  3. Buying Straddles into Earnings
  4. Dividend Capture using Covered Calls
  5. Effect of Dividends on Option Pricing
  6. Leverage using Calls, Not Margin Calls
  7. Bull Call Spread: An Alternative to the Covered Call
  8. Understanding the Put-Call Parity
  9. Difference between a Futures Contract and a Forward Contract

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Writing Puts to Purchase Stocks

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Put-call parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in 1969. It states that the premium of a call option implies a certain fair price for the corresponding put option having the same strike price and expiration date, and vice versa.... [Read on...]

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