If you already manage your own investment account and know how to buy and sell individual shares of stock, you can learn this way to pay less for the stocks you buy.
Why I Use This Strategy:
I almost never buy stock outright any more. Instead, I use this simple strategy to lower the cost of stocks I want to buy. When you are building your portfolio, every little bit of money you save compounds to help you increase your bottom line!
How does it work?
Other investors will pay you up front to promise that you will buy 100 shares of stock at a price you select. (Really! At first, I couldn't believe it either. The reasons they do this are beyond the scope of this blog post.)
These options contracts are always for 100 shares of stock. So, to get paid up front to buy stock you want, you just need to follow these steps.
1) Pick a stock of which you want to buy 100 shares and check the current share price.
2) Decide a price you would like to pay for it (ideally, just a little lower than the current share price). This is your strike price.
3) Find the options charts on your brokers site. There will be lots of strike prices and various expiration dates to choose from.
4) Look at the options chains for the next 1-3 months. There is a call side and put side of each chart, with bid prices (offers) and ask prices for each possible contract. (Don't worry about the calls for now. We can talk about how to use them at another time.)
5) Find your strike price and look at the bid (or offer) for the put at that strike.
6) Subtract the put offer/bid from the strike price. This is the amount you would actually be paying for the stock if it is assigned to you.
7) Choose a date and a strike price, then write an order with an offer to sell the put. (You can usually ask for a little more than the current bid.)
8) If your offer is accepted, you will get cash in your account.
9) The option contract will show up as a negative number in your account until the day it expires. This is the amount you would have to pay back if you changed your mind and wanted get out of the contract.
10) On expiration day, one of two things will happen; you will be assigned to buy the stock at the (strike) price you agreed to pay, or the contract will expire and disappear from your account.
11) Either way, you keep the money you were paid up front.
Example:
I like NYCB. It’s a small bank stock that pays a dividend of about 5%. I want to buy 100 shares to add to my account and the current price is $11.87/share. I can buy 100 shares for $1187 today, but I’d like to save a little money on this stock, so I decide to write (sell) a put instead.
I see in the options chain a strike price of $12/share, with an offer of $.40/share for a put expiring next month.
I sell a put on NYCB, expiring next month, with a strike price of $12. Since the contract is for 100 shares, $40 comes into my account and is added to my cash balance.
My broker puts a “hold” on $1200 of my cash, that will be released when the contract expires. (This is the money that will be used to pay for the stock if I’m assigned to buy it.)
A line appears in my account for about (negative) -$40. This is what I would have to pay back if I changed my mind and wanted to get out of the contract. The number changes daily as we get closer to expiration or as the underlying share price changes, but I'm not worried about that.
On the expiration date, one of two things will happen.
1) The share price of NYCB is less than $12, so the $1200 that has been on hold in my account is used to buy 100 shares. I now own 100 shares of NYCB. The actual cost to me is $1160 ($12/share minus the $.40/share I got paid up front). I’m happy I bought it this way instead of paying $1187 for it.
or
2) The share price is more than $12 and the 100 shares of stock are not assigned to me. The $1200 that has been on hold in my account is released. The negative number in my account from the put contract disappears. I still have the $40 I got paid up front. (Maybe I’ll look at the options chain to see if I want to try again.)
Final Words
Options can be really complicated, and this is just about the simplest way to safely use them.
But heed this warning: You have to be really careful filling out the order form! If you accidentally buy instead of sell the option, you don’t get paid for it. If you sell the call instead of the put, you assume a huge risk. So check and double-check your order before you hit submit.
If this is still confusing to you, don’t try it until you are sure you understand the process. And if you would like some extra assurance, find a mentor to help you place your first few orders.
If my explanation makes sense to you and you want to give it a try, I really hope you’ll let me know how it goes!