Name Your Price for Your Favorite Stock With Short Puts

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If you’re anything like me, you’re likely to be bargain-shopping for the best deals in town.

But did you know that in addition to "naming your price" for hotels and flights and rental cars, you can do the same with your stocks?

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Selling short puts may be the perfect strategy for you if you know what price you want to pay for a stock, but can’t watch the daily fluctuations of the markets to be able to grab it.

And sure, you could put in a limit order to try to catch that price. But what if you’d rather have some "skin in the game" in the meantime?

Selling puts gives you the opportunity to buy the stock you want, at the price you want to pay. And even if the stock isn’t "put" to you at exactly the price you want, you can still get paid for trying.

Sounds pretty win-win to me!

Just a quick word of caution: You should only "sell to open" put options on stock you would purchase anyway. Otherwise, you could find yourself owning stock you didn’t really care to own.

The good news is, however, you aren’t tied to the stock if you don’t want to be. You can go out onto the open market and sell it right away or whenever you’re ready. If you use a limit order, you may even be able to name your price on the way out, too.

Selling puts against stocks you wouldn’t mind owning can amount to getting paid to place a buy order below the current market price.

For example, say you want to purchase shares of Anadarko Petroleum (APC), which my Global Resource Hunter and Junior Resource Millionaire subscribers recently exited for a nice gain, but you think it may pull back from its current price of $101 to $90 in the short term.

Many investors would place a resting buy order (good-till-canceled) with a limit of $90 and just hope APC dips and your standing order is eventually executed.

If APC doesn’t dip, the investor buys no shares.

Here’s How ‘Selling to Open’ a Put Works

Compare this to the "short put" seller. The put-seller wants to purchase the stock at its current level, but she is afraid it may fall to $90 … and doesn’t want to miss out on buying the stock at a discount.

This investor "sells short" the $90 put option that expires in 30 days for $2.25 (example price). One option contract represents 100 shares of the stock, so the investor who wants to buy 100 shares "sells to open" the $90 put. In exchange, she receives $225 ($2.25 x 100), less the broker’s commission and fee(s).

Now, if the stock goes up in the 30 days to $104 a share and the put options expire worthless, at least the investor receives $225.

If the stock falls to $90 at expiration, the put-seller must buy stock for $90; however, the investor has received $225 for agreeing to buy the stock at $90, making her effective cost basis only $87.75.

Not too shabby!

This chart shows you the profit and loss potential for a $30 stock that offers a "short to open" put at $1.25, or $125 per contract:

We see the maximum this investor can make is the $1.25 ($125 per option sold short to open) from the sale.

If the stock falls, you will start losing — but you don’t lose any more than you would have by buying the stock outright. An investor who is willing to purchase the stock anyway is different from a speculator who sells puts without the intention of buying the stock.

The put-seller who intends to purchase the stock is, in fact, potentially deferring the purchase but getting paid if the stock rises. He may have to buy the stock if it falls, but he was going to do that it anyway.

What’s the Catch?

There are Two …

#1: The first big trade-off of selling short puts to open for a stock you want to buy is that the stock can take off to the upside, leaving you with only the premium you received from selling the put.

#2: Most brokers, especially when you’re selling puts short to open in an IRA account, require that you have enough cash in your account to buy the shares at the strike price. That would be $9,000 for 100 shares of APC at $90 a share, as laid out in my example, available in your account at all times while the put option remains open.

The good news is, you can keep "selling to open" puts to "put" premium in your pocket for as long as you like. And when someone "puts" the stock to you at the strike price of your choice, you can be happy that you got in at a price you wanted.

After all, how many "regular" stock traders get to name their price for the stock they like?

Bottom line: Using short puts as a way to purchase stock you want to own at a discount can be a tough strategy to beat!

Watching Your Chickens,

James DiGeorgia