Using Put Options To Buy McDonald’s
The Dynamic Wealth Report
November 23, 2011
by Marcus Haber, Editor
Have you ever wanted to buy a stock but thought, "Not now, the price is
too high?" I certainly have. Sometimes waiting works out and the stock
drops to a more attractive price. But other times, the stock just keeps
moving higher and I miss out on some nice profits.
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There's an investment strategy that can help you get stocks at the
price you want to pay. What's more, this strategy can also put money in
your pocket immediately.
I'll tell you all about it in a second... but first, a little background.
The strategy involves using options to buy stock. It's not widely used
by the average investor, but it should be. The problem is most people
think options are too complicated.
But I'm going to change that... at least for this exciting option
strategy. And soon you'll never have to pay full price for a stock
again!
The strategy I'm talking about is... selling put options.
Here are some of the basics to get started...
First, you've got to do your research and find a stock you want to buy. It should be a stock that you wouldn't mind owning even if the price
drops significantly. Blue Chip stocks are usually good for this
strategy.
Once you have the stock, you'll need to figure out what price you're
willing to pay for it, preferably a price below the current market
price. Don't be afraid to choose a price that's 10% or even 15% below
the stock's current market price.
Next, you're going to need to pick a timeframe for the trade.
Remember, every option contract has an expiration date. Any time prior
to expiration, your put option can be exercised by the buyer. If that
happens, you'll have to buy 100 shares immediately.
Let's be clear, when you sell a put option, you don't have any say when
you'll have to buy your shares. Only the buyer of the put option has
that choice. The seller must buy the shares as soon as the option buyer
exercises the put. So, make sure you always have enough money in your
account to buy the 100 shares.
Getting back to timeframes... I like to use four months to a year. I've
found these time periods usually offer the best risk/reward profile. And
more importantly, they tend to offer the highest option premiums.
Ok, now you've got your stock, the timeframe for the trade, and the
price you're willing to pay.
Sounds good... let's see how the strategy works!
To make this easier to understand, I'm going to use a real world
example. Let's say you want to buy shares of McDonald's (MCD). Right
now the stock is trading at $92 a share. But you decide $85 is the most
you feel comfortable paying over the next four months.
Here's how you make your trade...
First, sell one March 2012 put option with a strike price of $85 for
$2.50 a share. Since each put contract controls 100 shares, you'll be
collecting $250. Your account will show you've sold one put contract and
your cash balance is higher by $250.
You're trade is on, now you just need to wait for McDonald's stock to
approach $85.
But hold on, as expiration approaches, some interesting scenarios can
play out.
If March expiration passes and McDonald's is still trading for $92 a
share, you're sitting pretty. The put option you sold expires and you
get to keep the $250 premium as pure profit. That's a 3% yield on the
cash you were holding to buy the stock! In addition, if you did this
every four months, that would be a 12% annual yield.
Let's face it... you're certainly not going to earn 12% interest from
your bank right now.
Now you can sell another put option on McDonald's and collect more
premium. And you can continue to capitalize as long as your put options
keep expiring worthless.
As you can see, you can use this strategy over and over to keep
generating income.
But here's the best part...
Let's assume McDonald's is trading at just under $85 a share, say $84,
at expiration. Now you're obligated to buy 100 shares of McDonald's at
$85. Again, no worries! You're still ok. After buying your 100 shares of
McDonald's and then subtracting the premium you collected for the sale
of the put option ($85-$2.50), you now own McDonald's at a price of
$82.50.
Do you see what just happened? You saved 10% on your purchase of
McDonald's shares.
Now you have one more choice to make...
You can immediately turn around and sell your McDonald's shares for $84,
a quick $150 profit. Or you can just go ahead and keep them to maintain
a long position in a solid Blue Chip stock.
No question about it, selling put options is a simple, versatile options
strategy. Not only can you use this strategy to generate recurring
income, you can use it to buy shares of good, quality companies at
discounted prices.
However you choose to use the put selling strategy, it's a powerful tool
for boosting returns!
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