Welcome to another installment of The Smart Option Seller blog.
These posts are written with the intent to help new and veteran option investors take their trading game to the next level.
Looking for a new spark? Need a new strategy? Just want some information on how option trading works? Then you've come to the right place.
My goal is to answer your questions, teach you strategies, and set you on the right path.
If you've been reading any of my work, you know I'm a huge proponent of option selling (versus option buying).
That's because it offers an incredible cushion for directional error, and believe me, we all get a stock's direction wrong at some point. Right?
And, option selling also offers incredibly high odds of profitability.
We're not here though to guess where a stock will be on a specific date (because that's super hard to do), but we're here to capitalize on one of the most amazing option strategies that allows us to name our price for a favorite stock.
Apple For 50% Off? You Bet!
Who's not a fan of Apple (AAPL)?
I mean, the company is just a beast, and the stock price has minted many a millionaire.
Here's the current daily chart.
In 2019, the stock rose an incredible 86%, and so far in 2020, it has already risen a solid 6.8%.
But with the stock currently near $313 per share, how's a smaller investor supposed to partake in Apple's future movement and not break the bank?
Well, there are a few option strategies to use, specifically the one I outline here, but today we're going to focus on trying to buy it on the cheap - 50% off.
Is that possible? Absolutely! We'll discuss my favorite strategy - selling an Apple put option.
We'll target the $155 level as an area where we'd like to buy the stock (example only!).
Seriously, how can we buy the stock at $155 when it's currently trading at $313?
Well, you can't, at least not right now.
But you can place an option trade that will allow you to potentially buy the stock at $155 at some point in the future. And at the same time, you'll receive a bit of cash for your troubles.
The option chain above shows the June 19, 2020 $155 put options with a bid/ask market of $.19 bid/$.31 offer, giving a mid-point fair value of $.25 per contract (the "premium").
What do we do with that information?
Well, by selling that put option contract (not buying it), $25 would be deposited immediately into your trading account.
Each option contract consists of 100 shares of stock, so by selling one contract, you're obligating yourself to buy 100 shares of Apple for $155 per share at any point between now and June 19, 2020.
And once again, $25 for each contract sold, will be deposited in your account.
If five contracts are sold, $125 will deposited into your account. But this obligates you to buy 500 shares at $155.
But we're still stuck with the question - how can we buy at $155 if it's currently at $313?
Well, we would need Apple stock to fall just over 50% for that scenario to occur.
Apple would have to shed half its value in order for us to buy it. Trade of the decade?
I'm sure many of us would be ecstatic to have that opportunity.
What Are The Odds Of That Happening?
Using our trusty probability calculator below, we can see the chances of AAPL losing half its value and dropping to $155 (and staying below) by June 19, 2020 is a solid 0%. Yes, 0%!
Said another way, it has a 100% chance of staying above $155.
Why does this matter and why are the probabilities important?
Because it gives an idea of how probable it is for a stock to move a certain distance within a certain time frame. This can help formulate a high probability trade.
If AAPL stays above $155 by June 19, 2020, the put option contract will expire worthless and the $25 is your consolation prize.
You won't get to buy Apple at $155, but at least you made $25 per contract.
But if by some crazy occurrence all heck breaks loose and Apple falls to $155 by then, you will be called upon to buy the 100 shares at the 50% discount from the original $313 price.
Just an fyi - if that does occur, $15,500 would be needed to cover the cost of the trade.
The best part? We wait for the eventual rebound and watch the value of the shares soar again.
Now, you may be thinking - $25 is not much money. That's what lots of newbies think.
But do you know how many stocks you can find that you could sell put options like this and have an almost 100% chance of winning? And by winning, we mean having the put options expire worthless and you walking away with the premium.
Do that multiple times throughout the year on multiple stocks using multiple contracts, and before you know it, you've collected a tidy sum.
Do investors really do that? You bet! We do it all the time in our Smart Option Seller newsletter.
Our goal isn't so much to buy the stock, it's to collect gobs of premium throughout the year and watch our portfolio value grow.
And in the off-chance we have an opportunity to buy a stock like Apple at 50% off, we'll take it. Wouldn't you?
How About This...
Now, let's say you're interested in a higher chance of actually buying the shares.
In order to do that, the strike price just needs to be changed up. And as a bonus, a bigger payout can be received.
Instead of selling the $155 put options, the $280 strike put options could be sold.
It's a much different scenario all around.
Here's the details:
1. At a mid-point price of $7.25 per contract, it would deposit $725 into your account for each contract sold. Selling 10 contracts would deposit $7,250. Remember, each contract consists of 100 shares, so stay in your comfort zone.
2. There's still a $33 cushion between Apple's current price of $313 and the strike price of $280. Apple would have to fall 10.5% by June in order for the trade to come to fruition.
3. If Apple falls to $280 by June, $28,000 would need to be on hand to cover the cost of 100 share purchase. $280,000 would be needed to cover 1,000 shares (10 option contracts).
4. If Apple remains above $280 by June expiration, the put options expire and the $725 remains in your account.
What are the odds of Apple falling to $280 by June?
There's only a 21.75% chance that it will fall below $280 by June.
Only you can make the call on which strike price and which expiration to choose.
There's opportunities to not only buy stocks at ridiculously cheap prices (Apple at 50% off), but in the process, money can be collected just for placing the trade.
I hear from readers all the time about how much they love selling put options and collecting the money. Here are some of the testimonials.
Selling put options can offer a much different way to approach the stock market, and a high probability of profit.
Picking a stock's correct direction really has no bearing on how this type of trade turns out.
That's why I love option-selling strategies so much.
Please give me your comments and send your questions. I would love to hear from you.
Until next time...