Writing Put Options - To Build Your Stock
Options are used to capture large gains with little capital investment.
Small speculators can use them in many ways.
One way they are used is to write put options for an issue in which you wish to build a position.
For example, you are looking to buy shares of Teague Manufacturing (a fictional company).
You read the annual report and analyze the financial statements.
You decide that the price you are willing to pay is $25 per share.
However, the stock is currently trading at $30 per share.
You don't have to keep watching the market for the stock to fall before you take action.
You can write put options for the shares at $25.
What you are doing is promising that if the shares of Teague fall below the price threshold during the life of the option, the purchaser has the right to require you to purchase those shares at $25.
In exchange for your promise, the buyer of your put options will pay you an insurance premium.
This amount can vary.
We'll say that you are paid $1.
12 per share to take on the risk.
If you wrote ten puts (options are for round lots of 100 shares), you will receive $1,120.
If the option expires and is never exercised, you receive the money.
If the option is exercised, it can lower your cost basis.
Instead of paying $25 per share, your actual cost will be $23.
88 per share.
The premium is subtracted from the price of the share.
Value investors are concerned with getting the highest profit possible at the lowest cost.
If you are a value investor, writing a put option can be very beneficial to your portfolio.
If the stock doesn't fall, you get to keep the premium payment.
If the stock does fall, you are paying for the stock what you originally planned to pay.
You determined what the stock was worth to you and you are able to take advantage of it.
Either way, you come out on top.
But there are risks to writing put options, as with any other investments.
You must be sure that the price you place on the stock you choose is appropriate.
You need to understand the relationship between the price and earnings per share.
Keep in mind that there are situations that would make a stock worthless or at least drop dramatically in price.
Choose companies that you are sure of for the duration of your option.
Make your investment decisions based on the numbers and not gut feelings or the need to make a fast dollar.
Look at both the economy and the industry before you start writing put options.
It sounds like a great way to make some easy money, but it isn't always a guaranteed win.
Small speculators can use them in many ways.
One way they are used is to write put options for an issue in which you wish to build a position.
For example, you are looking to buy shares of Teague Manufacturing (a fictional company).
You read the annual report and analyze the financial statements.
You decide that the price you are willing to pay is $25 per share.
However, the stock is currently trading at $30 per share.
You don't have to keep watching the market for the stock to fall before you take action.
You can write put options for the shares at $25.
What you are doing is promising that if the shares of Teague fall below the price threshold during the life of the option, the purchaser has the right to require you to purchase those shares at $25.
In exchange for your promise, the buyer of your put options will pay you an insurance premium.
This amount can vary.
We'll say that you are paid $1.
12 per share to take on the risk.
If you wrote ten puts (options are for round lots of 100 shares), you will receive $1,120.
If the option expires and is never exercised, you receive the money.
If the option is exercised, it can lower your cost basis.
Instead of paying $25 per share, your actual cost will be $23.
88 per share.
The premium is subtracted from the price of the share.
Value investors are concerned with getting the highest profit possible at the lowest cost.
If you are a value investor, writing a put option can be very beneficial to your portfolio.
If the stock doesn't fall, you get to keep the premium payment.
If the stock does fall, you are paying for the stock what you originally planned to pay.
You determined what the stock was worth to you and you are able to take advantage of it.
Either way, you come out on top.
But there are risks to writing put options, as with any other investments.
You must be sure that the price you place on the stock you choose is appropriate.
You need to understand the relationship between the price and earnings per share.
Keep in mind that there are situations that would make a stock worthless or at least drop dramatically in price.
Choose companies that you are sure of for the duration of your option.
Make your investment decisions based on the numbers and not gut feelings or the need to make a fast dollar.
Look at both the economy and the industry before you start writing put options.
It sounds like a great way to make some easy money, but it isn't always a guaranteed win.
