I just learned about an interesting strategy and was wondering if any of you guys do this. Here's how it works... Say, you're watching ABC stock, and it's trading around $30. And you're interested in buying if it pulls back to $25. So, instead of placing an order to buy at $25, you sell $25 puts. If the stock doesn't pullback to $25, you make money on the puts. If it does pullback to under $25, then the buyers of the options will exercise their put, and you will be long the stock at $25 like you wanted to be anyway. Plus, your purchase price is reduced by the premium you received when you sold the options. Sounded pretty good to me, but I wouldn't mind hearing from someone who's tried this.
This method is used everyday. Wade Cook, aka Piece of shit, advocated this method ... Thus take it with a grain of salt Good strategy if AND only if volatility is high One caveat: Payoff is pretty stable, unless you use leverage. Money is also tied up due to nakedness...
You've just described the strategy of "naked put selling". This is a strategy that can be done at different risk levels. What you're doing is selling "out-of-the-money" puts in hopes of buying a desirable stock at a lower price. So while you wait for the stock to possibly trade lower to the strike price, you get to keep the premium. Good luck.
problem is -- if the stock goes to $10 -- you still have to buy it at $25 -- so you are immediately down $15 - premium that you took in.
Isn't there some sort of stop loss strategy I can use? Let's just say I got $2 for the put. So, if the stock drops to $23, then I'm breakeven. If it drops under $23, I can buy the puts back for a small loss, right?
And what if the day you get filled they halt the stock and announce accounting fraud, poor earnings, etc etc.
What happens if the stock gap down 50% at open ? One of my friends bought a hot technology stock in ealry 2000. One morning when he woke up, the stock was down 50%. He immediately got an margin call.
Yea, that reminds me of something I read about Mark Cook. Seems he sold a bunch of calls, then the stock halted trading for awhile. When it started to trade again he was down $500,000...ouch!
"If it drops under $23, I can buy the puts back for a small loss, right? " yes you could buy the puts back at any time. selling naked puts has the same or slightly less risk (because of the premium recieved ) as being long the stock as long as you dont sell any more than you have cash available to buy the stock at the strike price.
Sell a strike $25 put Buy a strike $20 put You're out $5 - (profit from selling $25 - cost for buying $20)