Market participants are beginning to champ at the bit to take on a few new positions. I get it, it’s been a while since we’ve seen a string of positive signs for the market. But that surely doesn’t mean we should go all in. A methodical approach is certainly far more beneficial from a risk standpoint and if you told me I could make money while waiting to buy Apple (AAPL) stock at a discount, well, that would be even better.
You see, I rarely buy a stock or ETF at its current price. Why would I? There are much better alternatives.
If I’m truly interested in buying a security, I typically have a price target below the current price of the stock. Most investors just set a buy limit at their price target and hope they get shares at their chosen price. But that approach is short-sighted and, well, uninformed.
Because there is a much better alternative.
An alternative strategy that allows investors to collect premium while waiting for the stock to hit their price. That’s right, let me say it again, investors can essentially produce income while waiting for a stock to hit their chosen price. And the premium produced can be used as a potential source of income or to simply lower the cost basis of the stock they want to buy.
Why would you ever approach buying stocks any other way?
For instance, let’s say you are interested in buying Apple (AAPL), but not at the current price of 147.
You prefer to buy AAPL stock for 135.
Now, most investors, would simply set a buy limit at 135 and move on, right? But, in my mind that approach is archaic. Because you can sell one put for every 100 shares of AAPL and essentially create your own return on capital (depending on the strike you choose). Some say, it’s like creating your own dividend and in a way, I kind of agree.
A short put, or selling puts, is a bullish options strategy with undefined risk and limited profit potential. Short puts have the same risk and reward as a covered call. Shorting or selling a put means you are promising to buy a stock at the put strike of your choice. In our example, that’s the 135 strike.
If you look at the options chains for AAPL below you will quicky notice that for every 100 AAPL shares we want to purchase at 135, we are able to bring in roughly $3.80 or $380 per put contract sold, every 66 days. That’s roughly 3% every two months.
The trade itself is simple: Sell to open February 17, 2023, AAPL 135 puts for a limit price of $3.80.
So, by selling the 135 puts options in February, you can again, bring in $380 per put contract, for a return of 2.8% over 66 days. That’s $2,280 or 16.9% annually. You can use the premium collected from selling the 135 puts either as a source of income or to lower your cost basis.
Just think about that for a second.
You want to buy AAPL stock at 135. It’s currently trading for 147. By selling puts at the 135 strike, you can immediately lower your cost basis to 131.20. That’s 15.8% below where the stock is currently trading. And you can continue to sell puts over and over, lowering your cost basis even further, until your price target is hit.
Or, like most investors, you could just sit idly by and wait for AAPL to hit your target price of 135. Losing out on all that opportunity.
In review, by selling puts at the 135 strike we receive $380 in cash. The maximum reward is the $380 per put contract sold. The maximum risk is that the short 135 put is assigned and you have to buy the stock for 135 per share. But, you still get to keep $380 collected at the start of the trade, so the actual cost basis of the AAPL position is again 135 – $3.80 = $131.20 per share. The $131.20 is our breakeven point. A move below that level and the position would begin to take a loss. And don’t forget, we continue to sell puts thereby lowering our cost basis even further.
But remember, most investors would have purchased the stock at its current price, unaware there was a better way to buy a security. We rarely take that approach. We know better. We understand we can purchase stocks at our own stated price and collect cash until our price target is hit. It’s a no-brainer.
To learn more about how I implement my favorite options trading strategies, download my free report the “Essential Guide to High-Probability Trading.” Or, to trade alongside me, become a Cabot Options Institute member today!