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For years, institutional investors have known how to buy stocks at discount through a little-known trading trick.
Basically, institutional investors believed that only the individual investors pay retail.
But nowadays numerous individual investors have stumbled across this straightforward trick—and are employing it to snap up sought after stocks at a reduced price.
What’s this secret? Simple— one would sell put options on that stock.
Let me elaborate… As most of us know, buying stocks can be disappointing, especially when the stock value declines right after you purchase stocks.
To lower this risk, you could sell a put option on the stock instead of buying the stock immediately. Selling put options grants you the ability to select the “discount” price you are happy to pay for a stock— and also collect income as soon as you sell it.
If the stock price doesn’t drop below the discount price you’re happy to pay, you’re not obligated to purchase the stock. But you get to hold on to the income you collected from selling the put.
If the stock price does drop below the discount price, then the put option you sold is exercised. This means you are obligated to buy the stock, but you buy the stock at a discount. How does this work? Selling a put option is similar to preparing a limit order to purchase the stock at a below-market price.
Unlike a limit order, having said that, when you sell a put, you are paid in advance. And you get to hold on to the money you’re paid, even when the stock price doesn’t drop to your “limit” price (i.e., the puts strike price). But if the stock does drop to your limit price, then you get to buy the stock. And since you already collected money up front, you’re essentially buying that stock at a discount.
Selling Puts or Placing a Limit Order?
Let us give you an example.
Let’s imagine we’re in the month of June and you’re interested in a fictional company called XYZ, which is currently trading hands for $110 per share. You haven’t bought the stock since you believe it’s overvalued asking for $110 per share.
You will only purchase the stock if its share price drops to $105.
You have two possibilities: (1) Setup a limit order at $105 and stand by in hopes that stock drops back to that price, or (2) sell a put option as soon as possible with a $105 strike price which expires in September for $3.85 per share.
If XYZ drops below $105 prior to the third Friday in September (which is when the put expires), it will be immediately exercised. This means you have to buy the stock for $105 per share.
But you hold on to the $3.85 per share you collected for selling the put.
This means you’re actually purchasing the stock for $101.15 per share ($105 minus $3.85). So you are retaining $3.85 per share— this means you’re receiving a 3.5% discount!
So why isn’t everyone purchasing stock this way? Well, if the stock doesn’t drop under the “discount” price you selected, you don’t end up buying the stock.
So you don’t get to take part in any of the stocks following price appreciation. However the same thing occurs when you set up a limit order. If the stock doesn’t strike the price you decided on, you never purchase the stock.
A 3.7% Yield in Three Months? Where do we sign up!
Here is the difference, though—once you sell a put, you collect the premium immediately even if you don’t wind-up purchasing the stock.
So you still recieve a gain because of that advanced payment. In the XYZ Company example earlier, you would have collected a 3.7% yield ($3.85/$101.15) in shorter than three months’ time!
Compared to, once you arrange a limit order, you don’t recieve any money in advance. So you recieve no profit what so ever.
To sum up you could lower your risk through selling puts to buy stock under the current market price. I’m positive you can see why this strategy should be employed by every prudent stock investor!
Be warned, however: Just as you wouldn’t sign up to purchase surplus shares than you can afford when you submit a limit order, you should not sign up to purchase additional shares than you can afford when you sell puts on a stock.
Numerous brokers permit you to sell more put options than you can afford to have changed into stock. Do not be tempted by the appeal of excessive leverage!
You can restrict your stock purchase by caping the amount of put contracts you sell. Every option contract represents 100 shares of stock, so if you would usually purchase 400 shares of stock, you should cap your put sales at no more than four contracts.
How To Buy Stocks At Discount Conclusion
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