I have read numerous investing books over the years, and I try to implement as many of the strategies as possible from those books. I have read several books on trading stock market options and one of the most enlightening concepts is “the creation of money out of thin air”.
With this article, I am going to dive into this concept because most people are unaware that this is even possible.
Are there risks with this strategy?
Of course…as there are risks with all types of investments.
If you speak to someone that gives investment advice, they will tell you all about the pitfalls of clients who ordered them to purchase options who then went on to lose a ton of money. Most money managers do not endorse trading in options.
What makes options so difficult to invest in that money managers do not like investing in them? Statistics show that the large majority of individuals who buy options, lose money (some studies place this percentage at 80% or more).
Why do I think options trading is such a good strategy if the statistics are so heavily against the buyers?
The reason is because the people who are losing money in the options games are the ones buying options…the ones making a killing are the individuals selling options.
If 80% of buyers are losing money, that also means that 80% of option sellers are making money.
So, the game we like to play in regards to options is the selling of options.
On Monday May 23, 2011 I put in an order to sell 20 put options at a price of $4 on CIGX. I pocketed $675 dollars immediately from this transaction. I also had to tie up $8,000 in capital to cover the possible purchase of 2,000 shares of CIGX stock at $4.00 a share. CIGX was/is currently trading at $4.60. A quick glance at the stock chart for CIGX shows it in a recent uptrend. Over the past 3 months, it has risen from $1.75 to $5.00 where it traded down to around $3.00 near tax day. From that point onward it has been in a nice healthy uptrend. The main concept with this transaction is I would not mind owning CIGX stock at $4.00 a share. If you feel $4.00 is not a good price for CIGX stock, then you should not do this transaction.
So, in a nutshell the stock chart looks strong.
Now that the transaction is complete, what are the possible outcomes?
1. The stock stays above $4.00 and I get to keep the $675.00 from the put sell.
2. The stock goes below $4.00 and I have to purchase 2000 shares (ie 20 options = 2000 shares) at $4.00 even if the stock goes all the way to $0.00. (so there is a risk)
What do I do if the stock goes to $3.80 and I am forced to buy it at $4.00? I can do one of three things which are outlined below.
1. Take my new shares and sell a call option on it to earn additional money. (by selling a call I give someone the right to purchase my shares at a certain price for a certain time range)
2. I can do nothing and sit on my shares (this is what I won’t do)
3. I can sell the shares at a loss.
So, if I decide to do option 3 above, how much money will I lose if the stock price is at $3.80? I will lose $0.20 on the sell of stock, however I have made $0.35 a share on the original put sale.
I have actually made money on the overall transaction of $0.15 a share.
Thus, the beauty of the put sale. The real power of a put sale is when you pick out a stock you really would like to own in the near future for long term growth, but you aren’t in a hurry to buy the stock. If XYZ stock is trading at $20 a share and you feel it is a great buy at this price, then if you could buy it at $17.50 that should be even better for you.
So what I suggest you to do is to sell a put option on XYZ stock with a strike price of $17.50. You pocket the monies for the put transaction and if the stock does go below $17.50, you buy your shares. If the stock never goes below $17.50, you can re-sale another option the following month and make additional money.
If anyone has any questions, feel free to leave a comment or question in the comment box. You can also send an email or leave your email address in the comment box with your question and we will get back to you.
Hope you enjoy this new concept.