02/11/2020 @ 1:22 PM Central Time
You look at graph and see that Tesla Motors (TSLA) has increased dramatically in the past few months from about $231.43 per share on 10/02/2019 to a high of $968.99 on 02/04/2020 and settling now at $775.02 at the time you first saw the graph. This means if you would have bought it at what was considered a HIGH PRICE by many analysts on 01/16/2020 you would have paid about $500 per share for it and in three weeks it would have been up about 55% ($775 – $500 ÷ 500 = 0.55).
Look at the graphic below:
You think to yourself … “Boy if it ever get’s back to $500 I am definitely going to jump in on this stock.”
Not a bad thought.
However, it could get back to $500 and continue to decline in value. Or it may continue to increase in value from this point and it may be years before it gets back to $500 barring, of course, any future stock splits.
One idea would be to enter a “Limit Order” to purchase shares of the stock if it hits $500 per share. Make this a Good till Cancelled (GTC) order and that means at most brokerage firms it will be a standing order for at least 180 days. The advantage here is you don’t have to sit at the computer or stay in touch with your broker watching the stock. You could be out on the golf course chasing that little white ball around and if the stock touches $500 per share your order will be executed at the next market order (which could be a little higher or lower than $500 per share).
If it never hits the $500 the order could be entered again in 180 days for another 180 days. If it does hit $500 you will have three days to get your money to the broker (it’s always best to have the money in the account already). Now, if you were planning on buying 100 shares you will need to have $50,000 on the side earning next to nothing to pay for the stock when and if the order price is attained ($500 X 100 shares = $50,000).
Here’s a better idea to consider if you are sure you want the stock at $500 per share:
Sell a “Put” Option on the stock. When you sell a put option, you are agreeing to pay a certain price for the stock if that price (known as the strike price) is achieved before the option expires. Since you are selling the option … this means someone else must be buying the option. If they are buying the option … they have to pay a premium to the person that is selling it, and that person is you.
Perhaps the person buying the PUT option already holds the stock and perhaps they purchased this stock way back on June 3, 2019 when they got it for just $180 per share. They invested $18,000 for their 100 shares and saw in climb in a matter of a little more than 7 months to high of $968.99 per share (or a value of $96,899 for their 100 shares of stock that cost them $18,000).
Today they look at it and see that it is worth $77,500. They think to themselves … “Okay, for now I will hold this but I am going to take out an insurance policy that will allow me to sell this to someone if the price per share continues to fall.” They settle on a value of $500 per share for the stock … which would still provide them a nice gain from $18,000 to $50,000 (178% gain). Yes, you can buy insurance on stock portfolios if you know how.
This INSURANCE POLICY comes in the form of a Put Option at a strike price of $500 per share. This means that between now and the expiration date of the option if the price of the stock drops to $500 or less (even as low as the $180 they paid for it or lower) they can force the person who sold them the Put Option (that’s you) to buy the stock for $500 per share from them.
Let’s assume they choose an expiration date of March 20, 2020 (the Friday before the 3rd Saturday of the month which is when Monthly Options expire). If they were buying this option now at current rates it would cost them $4.80 per share (or $480 total) to ensure their stock could be sold for $500 per share should it fall to that amount or lower in the next 39 days.
You, the seller of the option, would get their $480 credited to your account and it would always be yours unless for some reason you decided to buy the option back to close out the transaction (and this could be at more or less than $480 that was credited to your account). But why would you close it out. You’ve already stated that you would be willing to pay $500 per share for the stock.
Now you have $50,000 setting on the sidelines waiting to buy you some stock and this $50,000 just made you 0.96% for a period of 39 days. You know a bank, nor a broker, would pay you 0.96% interest today in a year … let-a-lone in a period of 39 days.
Alright let’s assume the price does not hit $500 in that 39-day period. At the end of the period you make a decision … do it again at the same strike price or different strike price and sell another Put Option … or do something else. In either event you made $480 for not doing much of anything.
Let’s assume you decided to do it again … and you continue doing it again at least 11 more times. In approximately one year if the stock is never purchased, and assuming premiums remain about the same, you will generate a total of $5,760 for waiting on a stock to hit a price you are willing to pay for it.
If you simply divide $5,760 by $50,000 you end up with a gain of 11.50% for letting your $50,000 nest egg sit on the sidelines. Back in the early to mid 1980’s banks would pay money like this for a 5 year Certificate of Deposit (CD) … but it is likely that the interest rates we saw in this country 35-40 years ago for safe money will not be seen again.
During any of these periods that you have sold the options you may have to buy the stock and you will invest the $50,000 that you stated you would be willing to invest in the stock.
In general, getting paid for waiting is a whole lot better than waiting and not making any money.
So, the upside is that you get paid to wait for the stock you are willing to purchase at a price lower than it is today – which could possibly add to your overall investment return.
What’s the downside?
If the stock should fall to a price a lot lower than $500 you may be forced to purchase a losing stock. For example, if the stock should fall to say $300 per share … you will have to pay $50,000 for 100 shares on stock that is only worth $30,000. It may mean you have to wait awhile to make your money back.
However, you always have the right to sell Call Options on the stock you now own. So, if you paid $50 for a $30 stock you could sell call options to give you the obligation to sell your stock back to someone who is buying the call option for a higher price than the stock is now worth. We will discuss this in a future article.
Bottom Line:
There are numerous ways to make your money make more money in the stock and options market. Whether you are doing options, stock or a combination … the bottom line is that you always want to sell at a higher price then you buy at. Selling a Put Option does this for you because it cost you nothing to sell it (other than a few cents in commission charged by some brokers). Another thing to consider is just because you think a stock is high does not mean it can’t go higher … look at the two graphs below:
Also, just because a stock has had a trend up does not mean it cannot start to trend down at the drop of a hat or stupid words of a politician or media person. This is why you should always use some kind of money management techniques such as profit and loss targets.
Have an entry plan and an exit plan in all your investment decisions. Have a written plan and stick to that plan. You will see where I state this over and over in my writings.
For now let me know if you have any questions.
Go make some Investment Waves,
Jerry Nix | Freewavemaker, LLC
Disclaimer:
The information shared in this article is not meant as investment advice. Before acting on any of these investments referenced herein that was meant for education only, please check with a qualified professional like a financial planner or broker that you may be working with. These investments may not be right for you at this time.
The writer of this article does not own any investments mentioned in this article at the present time nor does he intend to do so for the next 48 hours.