Is it true that you can't buy stock by writing puts on it?

Question

If the puts get excercised, doesn't that imply that you would be automatically buying the stock from the person who excercised the puts? I asked another options question here and one of the answers said you would never end up with a long position in the stock by writing puts. They said a covered put requires that you hold a short position in the stock. But what if you want to cover it with cash, to buy the stock from the person who excercises the put? Isn't that a safer way to cover the puts you write?

Answer 1

That's not true. If you sell a put and the owner exercises it, you just bought their stock at the strike price of the contract. Selling naked puts is a risky strategy that has a bad risk/reward ratio. If you want to sell puts as a way to generate income while eventually buying a stock you want to own, I would recommend a bull call spread, rather than naked puts. It will accomplish the same thing, but with a limited amount of risk. The one drawback is you won't capture as much premium



A bull call spread is created by selling a put and then buying the same number of put contracts at a lower strike price than the one you sold. The purchase of the lower price puts protects you is the stock has a significant drop.

Answer 2

You have described what is called a "cash-secured put".



This is, in fact, a way of acquiring a stock that you have every intention of acquiring, except that you get a "discount".



Here's how it works.....





You like stock XYZ, which is presently at $45. You are prepared to buy the stock. You already have enough money in your account to buy it.



You look at the Put option for XYZ and notice that the December 45 Put is bid $0.50.



You can now sell the Puts ( 1 contract equals 100 shares ) for $0.50.



Now you wait.



If, on close of market Friday Dec 17th, the stock is going for anything more than $45, you simply pocket the $0.50, and repeat the strategy ( you may decide to change the strike price or the month fo expiry ). In this case, you have made a clean $0.50 times however many shares was involved in your transaction.



However, if the closing price on Dec 17th is $44.00, then you will be assigned the options and you have to buy the shares for $45 -- but you previously pocketed $0.50, so actually your effective price is $44.50. Viola! you have bought the stock at a discount.



The above is a very simplistic example, but it explains the concept. I have ignored commissions, in this example, but they can be significant and you have to consider their effect.



You could actually buy back the puts anytime before expiry, and have a capital loss or gain accordingly.



Note that you have to be approved for Level 4 options trading before you can sell naked ( or uncovered ) puts.





In another strategy, you could open a position by shorting the stock, then selling a "covered put". Then if the put is exercised, you simply buy the stock, and deliver against your short position and close out the trade that way. But I think this is more dangerous, because shorting a stock can be very expensive if the market turns against you ( margin calls, etc ).

Answer 3

Another way of accomplishing essentially the same thing (and perhaps with an advantage) is to write a put option on that stock with a strike price of $45/share. A “put option” is a contract that gives the holder the right to sell a stock for the strike price indicated for as long as the contract is in force (the “term”). These contracts have value, and by “writing” a put contract you are SELLING someone else this contract. This contract holder will have the right to sell their stock and you must agree to purchase it at the strike price.

So let’s go back to our example. Stock XYZ is trading at $50/share and you would love to be able to buy it for $45/share. Instead of placing a stink bid for $45/share, you sell someone a put option on the stock with a strike price of $45/share (1 contract is for 100 shares) and a term of 6 months. You sell this contract for $1.50/share (or $150 total for one contract). No matter what happens, this $150 is yours to keep. If in the next 6 months, stock XYZ never makes it down to $45/share the option holder won’t have any reason to force a sale of XYZ to you at $45 and the contract will expire worthless. If you still wanted to potentially buy it for $45/share, you could just turn around and sell another contract and collect the premium again.

If XYZ does make it down to $45/share (or lower), then the option holder may exercise their option to sell the stock to you at $45/share. So what has happened? The stock that you were willing to purchase for $45/share is yours for $45/share plus you pocketed $1.50 share extra. So really the cost is more like $43.50/share.

Answer 4

If I understand your question properly, you are describing an options technique termed the selling of a cash-secured put. This can be an excellent method of acquiring stock at a lower price ... and be payed in the form of option premium to do it. The details of this very useful technique are discussed at length at the following website: http://www.safe-options-trading-income.com/Cash-Secured-Puts.html

Answer 5

Writing a put will make you long if the option is in the money at expiration. Asking strangers, whose qualifications & motives can never be known... will certainly lead to very uninformed & stupid answers.