With stocks brushing up against all-time highs… it’s become harder and harder to find value in the market. However, that is where turning to options can become advantageous.
You see, with options trading the possibilities are endless. For example, if you are bullish a stock… the only way to play it with equities… is to buy shares.
However, I’m about to introduce you to a bullish options strategy, that allows you:
- Profit if the stock rises
- Profit if the stock barely moves
- Profit if the stock drops slightly lower
It’s not bulletproof, but as you can see, it offers more opportunities to win. And that’s always a good thing to have as a trader.
Now, unlike most options strategies, this one is simple and straightforward. But despite that, you’d be surprised at how overlooked it is. However, I just closed out a winning trade, utilizing the strategy.
What if I told you there was a way to make money in a stock before you buy any shares?
You’re probably thinking it’s too good to be true…
… but it’s not.
You see, I’m talking about naked selling put options.
If you don’t know, when you short put options… you’re able to collect premium as long as the stock stays above the strike price that you sold.
However, if the stock actually falls below the strike price and expires in the money… you’re obligated to buy shares of the stock at the strike price.
Now, the strategy has downside risk… and your maximum reward is limited to the premium collected.
For example, let’s say you sell five $25 strike price puts in a stock for $0.50… and let’s say it closed at $24.75 on the expiration date. Well, you collect a premium of $250 (100 * 0.50 * 5) from the start.
Thereafter, you would be long 500 shares at $25 (you’re obligated to buy shares if the option expires in the money).
With that said, you can make money in a stock before you buy it… and selling put options has many advantages.
So when would anyone want to use this strategy?
Well, if you’re bullish on a stock and willing to own it at a specific price… it may make sense to use the strategy.
If you think the stock will stay above a certain level or have neutral trading activity… the strategy could be powerful.
Advantages of Short Put Strategy
With this strategy, the advantages outweigh the disadvantages.
Downside risk if the options expire in the money and the stock sells off after.
|Multiple scenarios to profit|
|Requires less capital than buying stock outright|
|Can generate income|
You see, when you sell options… time is on your side. You can read more about how time decay benefits options sellers here.
There are actually multiple ways to profit from a short put. If the stock gains in value, moves sideways, or just drops a little bit… you make money. Just as long as the stock is above the strike price, you’re in the clear.
When you buy shares… you actually have to put the money upfront. Think about buying 1,000 shares of a $20 stock… that’ll cost you $20,000.
However, if you sell 10 put options (options have a 100 multiplier) – which would control 1,000 shares – to establish your bullish position… it won’t use as much capital as just buying stock outright.
Not only that, it could be a way to generate income on the sign.
Now, here’s how I use the strategy.
Using the Short Put Strategy – Case Study
If I’m bullish on a stock… and willing to own shares at a specific level… I may look to sell puts.
For example, here’s a look at the daily chart in Amarin Corp. (AMRN).
The stock has sold off due to a secondary offering, which was priced at $18. Keep in mind, secondary offerings dilute the stock and cause selloffs. However, if you look at the chart above, $18 is a clear support level.
What that means to me is that there is demand at that level, and traders are likely to buy the stock around $18. That said, it had a high probability of rebounding from that level. As you can see, the stock just broke slightly below $18 before closing around $18.50.
Rather than buying the stock outright and having to use a lot of my capital… I decided to sell puts, and of course, I let my clients know about it.
Now, I sold the $17.50 puts in AMRN for $0.52. That means as long as the stock stayed above $17.50… I would collect all the premium. However, if the stock closed below $17.50 on the expiration date… I would have to buy shares at that price.
But what happens if you change your mind and don’t want to own at $17.50 anymore.
Well, you can actually close out the position and lock in a winner… and generate some income.
That’s exactly what I did with AMRN.
The stock is reporting earnings next week… and I don’t want to hold this position into that volatile event.
You see, if the stock misses expectations… I don’t want to own the stock at $17.50 anymore because it could be trading well below that after earnings, and those options expire a few days after its earnings announcement.
By closing out the position, I locked in around 50% on the trade… and minimize my risk.
Now, if you’re interested in learning how to use multiple strategies to improve your chances of beating the market… and find clarity amongst all the chaos in the market… then you’ll want to check out this video lesson on my latest trading system – what I call Black Options.
However, you’ll have to hurry because I’m only allowing a handful of people to sit in on the session. Click here to register.
[Ed.note: Kyle Dennis runs BiotechBreakouts.com. He is an event-based trader, who prefers low-priced and small-cap biotech stocks.
Source: BiotechBreakouts.com | Original Link