Nothing is more frustrating than waiting for a stock to drop to your limit and never getting the transaction filled. This practice goes on just about everyday in the world of trading. The dreaded "limit" order to buy, at a price lower than the current market value.
Transfer your account to optionsXpress...We'll cover your fee!
* optionsXpress rated "Best" by Barron's, SmartMoney and Forbes
Note: Options involve risk. Risk disclosure:
Option #1: A limit order to buy FGH at $45.
Option #2: The selling of a FGH June $45 put for a net credit of $1.75 or $175 per 100 shares.
Now given the two options above, the market in terms of scenarios can only do 1
Let's look at what happens with each of these scenarios.
Scenario #1: The market goes down.
If the market goes down and FGH goes to $45, your limit order goes off and you get the stock at a price of $45 a share. That was your intend, Right!
However, in option #2: You get 100 shares of FGH put to you at the price of $45, but remember you received $175 or $1.75 a share for the put option that you sold. So in option #2, you actually get the FGH stock for a net cost of $43.50. That is $45 a share minus the $1.75 a share you received for the put option. Hence, you spend $1.75 a share less to own the same stock as if you just used a limit order. But you now say, what happens if the stock goes to $30! Sure you are losing money, but let's compare apples to apples. No matter how low the stock goes remember the intent of the transaction, you wanted to OWN this stock and no matter how low it goes you will still have paid $1.75 less per share by using the "put write", then if you just used the "limit order"
They are both the same. Here's why. If FGH never goes down or goes up, your limit order will never be executed. Hence, you do not get the stock and in fact you get nothing but a waste of your time hoping the stock would have gone down. However, with option#2, even if the stock stays the same or goes up, you still keep the $1.75. Remember with the limit order you would have never gotten the stock, but at least with the "put write", you receive a premium credit of $175 for every 100 shares. "Sort of like getting paid while you wait for the stock to come down to your price." In addition, you can "sell another put" when your put expires. This becomes really interesting if the stock hasn't moved down much, but really interesting if the stock has moved down close to your asking price. You can get more of a premium when you sell the FGH July $45 put if the stock is less then $49.50 but not quite $45. When you compare all the scenarios, you can see how the put write is the better option (no pun intended) then the limit order. whether the stock goes up, down or stays the same.