We'll talk about how value investors trade options. What option selling strategies do we use for long-term investing?
Hi, I'm Henrikh. I will share with you how I trade short-term options with value investing long-term principles, how I buy stocks cheaper than the market price, and how I sell them later higher than the market price. For instance, the stock is trading at $33, but I buy it paying only $30, and when it reaches, let's say, $56 I sell it and get $60. So, I pay $30 and get paid $60, even if the price doesn't reach $30 or $60 EVER.
But before we start, I want to mention that I am not a financial adviser, and I don't provide any investment recommendations. Before you invest in anything, do your own research and analysis. Also, options contracts are considered high-risk investment tools, so please don't trade until you get enough education.
Ok, let's move on.
Let's say I've done my full investment analysis for a stock XYZ and found out that $30 is a great buying price for me, including the "margin of safety" strategy. But the problem is that XYZ is trading at about $33 to $35, and I don't know if it will drop to $30 or below that ever. Meanwhile, I’m not going to pay more than $30 for the XYZ stock. I really want to own that stock, but my investing rules don't let me buy it at $33. And I always try to act in accordance with my investing rules. On the other hand, the price can rise from $33 to $40 or $50 and never come back. I will not be happy if I lose the opportunity to own this stock. But the advanced investors should position themselves in the market in a way that makes them happy; however, the market moves. The intelligent investor should be prepared for all directions.
So what should I do to own the stock for only $30?
There are actually many ways to play it here with different options strategies, and I will cover one of them. So, in this case, I sell a PUT option as Warren Buffett does. I sell a PUT option with a strike price of $31 to $35, depending on the premium size and the expiration period. When I sell a PUT option, let's say, with a $32 strike price and, let's say with a 1-month expiration period, that means that I get paid in the upfront to promise that I'm willing to buy the XYZ stock at $32 if the price drops to $32 or below. And in this example, I get paid $2 per contract for the promise I've made.
To sum up the case, I promise to buy the stock at $32, for what I get $2 in the upfront. And, as always, three things can happen, the price can go up, down or stay sideways. So if the price drops below $32, I will be happy to buy the stock paying $32 and getting $2 in the upfront so that my cost basis will stay at $30. If the price stays sideways, I will pocket the $2 premium and will sell new PUT contracts, and finally, if the price goes up, I will lose the opportunity to own the stock, but instead, I will still pocket $2 per share on the stock I never owned. In short, I will make money out of thin air, or I will buy the stock I want to buy at a price I want to pay. There is no other outcome. And that's what is called "advanced investing.". This PUT selling strategy is called a "naked PUT" or a "cash-secured PUT," and it is a very powerful strategy when you combine it with Value Investing principles. Otherwise many people lose a lot of money doing it wrongly. So in this case, I buy the shares paying only $30, regardless of the price dropping to $30 or not. It can stay at $31, and I still own it on a $30 cost basis. That is an example of a 1-month expiration contract. The same applies to longer-term contracts. Let's say the price is $35, and you sell PUT options with an expiration period of 3 months, and you get paid $5 instead of 2$ upfront. There are many variations of this contract-selling, but the logic behind this strategy is the same; to own shares cheaper than the market price.
The next step after buying the shares at $30 is to WAIT. The best thing an investor can do in many situations is to wait. As Warren Buffett said, "The stock market is a device for transferring money from the impatient to the patient.". In investing, we should learn to wait if we want to be successful. So we wait until the stock price reaches about $55-57 to be able to sell it at $60. The opposite thing is done when the price reaches closer to the levels where we want to sell. Let's say the price is trading at $56 now.
The next thing I do is to sell CALL options on the stock I own at a strike price I want to sell. In this example, I'd sell CALL options with a $57 strike price, for which I’ll get paid $3 per share upfront. And, as always, three things can happen. The price can go up, down, or stay sideways. In the case it goes above $57, I will have to sell my shares at $57, and I will pocket the $57 per share and the $3 per share for the options contracts I sold and got paid upfront. So selling the shares and the options contract together will bring me $60 per share. And if the price stays sideways, I will just pocket the $3 profit and will sell new CALL options again for another period. And, if the price drops I will continue waiting for the price to go up as I did before, but again with $3 profit per share, which will make my cost basis deducted by $3 per share. So still, I will be happy in all directions. No other case can happen. And this strategy is called a "covered CALL" strategy, which again becomes very powerful if you combine it with Value Investing principles. Again many people lose a lot of money doing it wrongly.
To sum up, I pay $30 for a stock that is trading at around $33-$35 price range, and I sell the share and get $60 for a stock that has reached $55-57. So the price moved about $20 to $24, but I made a profit of $30. And $30 is the minimum I make on this price movement as this is the case where all the contracts I sold on the first trial got exercised. Imagine a situation where you sell an options contract, and the price stays sideways, you profit from the premium paid in the upfront and then sell options again, and the price remains sideways. This way, the $30 profit is the minimum to make as every time you sell an option contract, the cost basis to own the stock is deducted. It can go to 27, 24, 21, and so on each time, you sell the contract until the shares are put into your portfolio so that the profit can go from $30 to 33, 36, 39, and whatever, on the stock price that moved about $20-25.
A mistake I used to make was to sell CALL options on the stock, which is trading below its fair value. In this example, if I start selling the covered CALLs when the price was still trading between $30-40, I may lose my opportunity to be invested in a very wonderful company and gaining from stock price appreciation, because when the CALL option contracts expire IN-THE-MONEY, I'm obligated to sell my shares at a promised strike price. It is a very annoying situation when you deeply analyze a company, love to own it, wait for it to drop in price, buy it, and lose it very soon without giving it time to rise in price. So selling CALL options too early can be very confusing for a long-term value investor.
We'll talk about how value investors trade options. What option selling strategies do we use for long-term investing?
Hi, I'm Henrikh. I will share with you how I trade short-term options with value investing long-term principles, how I buy stocks cheaper than the market price, and how I sell them later higher than the market price. For instance, the stock is trading at $33, but I buy it paying only $30, and when it reaches, let's say, $56 I sell it and get $60. So, I pay $30 and get paid $60, even if the price doesn't reach $30 or $60 EVER.
But before we start, I want to mention that I am not a financial adviser, and I don't provide any investment recommendations. Before you invest in anything, do your own research and analysis. Also, options contracts are considered high-risk investment tools, so please don't trade until you get enough education.
Ok, let's move on.
Let's say I've done my full investment analysis for a stock XYZ and found out that $30 is a great buying price for me, including the "margin of safety" strategy. But the problem is that XYZ is trading at about $33 to $35, and I don't know if it will drop to $30 or below that ever. Meanwhile, I’m not going to pay more than $30 for the XYZ stock. I really want to own that stock, but my investing rules don't let me buy it at $33. And I always try to act in accordance with my investing rules. On the other hand, the price can rise from $33 to $40 or $50 and never come back. I will not be happy if I lose the opportunity to own this stock. But the advanced investors should position themselves in the market in a way that makes them happy; however, the market moves. The intelligent investor should be prepared for all directions.
So what should I do to own the stock for only $30?
There are actually many ways to play it here with different options strategies, and I will cover one of them. So, in this case, I sell a PUT option as Warren Buffett does. I sell a PUT option with a strike price of $31 to $35, depending on the premium size and the expiration period. When I sell a PUT option, let's say, with a $32 strike price and, let's say with a 1-month expiration period, that means that I get paid in the upfront to promise that I'm willing to buy the XYZ stock at $32 if the price drops to $32 or below. And in this example, I get paid $2 per contract for the promise I've made.
To sum up the case, I promise to buy the stock at $32, for what I get $2 in the upfront. And, as always, three things can happen, the price can go up, down or stay sideways. So if the price drops below $32, I will be happy to buy the stock paying $32 and getting $2 in the upfront so that my cost basis will stay at $30. If the price stays sideways, I will pocket the $2 premium and will sell new PUT contracts, and finally, if the price goes up, I will lose the opportunity to own the stock, but instead, I will still pocket $2 per share on the stock I never owned. In short, I will make money out of thin air, or I will buy the stock I want to buy at a price I want to pay. There is no other outcome. And that's what is called "advanced investing.". This PUT selling strategy is called a "naked PUT" or a "cash-secured PUT," and it is a very powerful strategy when you combine it with Value Investing principles. Otherwise many people lose a lot of money doing it wrongly. So in this case, I buy the shares paying only $30, regardless of the price dropping to $30 or not. It can stay at $31, and I still own it on a $30 cost basis. That is an example of a 1-month expiration contract. The same applies to longer-term contracts. Let's say the price is $35, and you sell PUT options with an expiration period of 3 months, and you get paid $5 instead of 2$ upfront. There are many variations of this contract-selling, but the logic behind this strategy is the same; to own shares cheaper than the market price.
The next step after buying the shares at $30 is to WAIT. The best thing an investor can do in many situations is to wait. As Warren Buffett said, "The stock market is a device for transferring money from the impatient to the patient.". In investing, we should learn to wait if we want to be successful. So we wait until the stock price reaches about $55-57 to be able to sell it at $60. The opposite thing is done when the price reaches closer to the levels where we want to sell. Let's say the price is trading at $56 now.
The next thing I do is to sell CALL options on the stock I own at a strike price I want to sell. In this example, I'd sell CALL options with a $57 strike price, for which I’ll get paid $3 per share upfront. And, as always, three things can happen. The price can go up, down, or stay sideways. In the case it goes above $57, I will have to sell my shares at $57, and I will pocket the $57 per share and the $3 per share for the options contracts I sold and got paid upfront. So selling the shares and the options contract together will bring me $60 per share. And if the price stays sideways, I will just pocket the $3 profit and will sell new CALL options again for another period. And, if the price drops I will continue waiting for the price to go up as I did before, but again with $3 profit per share, which will make my cost basis deducted by $3 per share. So still, I will be happy in all directions. No other case can happen. And this strategy is called a "covered CALL" strategy, which again becomes very powerful if you combine it with Value Investing principles. Again many people lose a lot of money doing it wrongly.
To sum up, I pay $30 for a stock that is trading at around $33-$35 price range, and I sell the share and get $60 for a stock that has reached $55-57. So the price moved about $20 to $24, but I made a profit of $30. And $30 is the minimum I make on this price movement as this is the case where all the contracts I sold on the first trial got exercised. Imagine a situation where you sell an options contract, and the price stays sideways, you profit from the premium paid in the upfront and then sell options again, and the price remains sideways. This way, the $30 profit is the minimum to make as every time you sell an option contract, the cost basis to own the stock is deducted. It can go to 27, 24, 21, and so on each time, you sell the contract until the shares are put into your portfolio so that the profit can go from $30 to 33, 36, 39, and whatever, on the stock price that moved about $20-25.
A mistake I used to make was to sell CALL options on the stock, which is trading below its fair value. In this example, if I start selling the covered CALLs when the price was still trading between $30-40, I may lose my opportunity to be invested in a very wonderful company and gaining from stock price appreciation, because when the CALL option contracts expire IN-THE-MONEY, I'm obligated to sell my shares at a promised strike price. It is a very annoying situation when you deeply analyze a company, love to own it, wait for it to drop in price, buy it, and lose it very soon without giving it time to rise in price. So selling CALL options too early can be very confusing for a long-term value investor.
