Imagine buying ATT (NYSE: T) for $25 a share, Cisco (Nasdaq: CSCO) at $16 or Microsoft (Nasdaq: MSFT) for $20.
And imagine not only buying these or any stock at a much lower price -- but actually being paid to do so.
Sound too good to be true? I know it seems like a dream, but sophisticated investors accomplish this on a regular basis. Here's how...
Limit Orders: You Set The Price
The average investor accomplishes buying stocks lower than the current asking price by using a limit order.
By specifying a chosen share price, your order isn't filled until the stock dips to your set price. If the stock never reaches your limit order price, then you get to keep your money. The downside is that it can take forever for the stock to dip to your price and you don't get paid for waiting. Also, limit orders often cost slightly more commission than traditional market orders from most stock brokers.
But this method actually pays you for the time you spend waiting for the price to dip.
The best part? If the share price never hits your buying level, then you get to keep the money you were paid to wait. This tactic is simple and easy to follow with the worst thing likely to happen is that you need to purchase your desired stock at your chosen lower price.
Put Options
The way this method works is by selling a put option at the strike price you want to buy the shares.
One put option equals 100 shares of stock, so you sell one put for every 100 shares of stock you want to buy at the strike price of the put. As the put seller, you then immediately receive the proceeds from the price of the put as profit.
Then, one of two scenarios can happen.
1 .The price of the stock stays above your chosen strike price. If this happens, then you simply get to keep the premium for the put option and are not forced to buy the stock..
2. The price of the stock drops to the strike price of the put. In this case, you will buy the stock at the strike price, getting the price you wanted in the first place. You also get to keep the money you received for selling the put, thus lowering the overall cost of your trade.
Let's take a look at a real-world example...
Say you want to buy 1,000 shares of Cisco at $16 a share (the current market price is about $21). Therefore, you need to sell 10 Cisco April puts at the $16 strike price at the present cost of $0.09 per put. This means each put is worth $9, and 10 puts is $90.
This $90 is wired immediately into your account.
Now comes the waiting game.
Should Cisco dip to $16 a share or below, then you will be forced to buy the 1,000 shares at $16 each. Remember, you have the $90 put premium to apply toward the purchase price. Therefore, rather than costing you $16,000 to purchase the 1,000 shares, it now costs $15,910 when you include the $90 put premium. This means Cisco can drop all the way to $15.91 a share before your investment turns negative.
If Cisco never falls to $16, then you don't get to buy the shares at $16, but you get to keep the $90 put option premium as payment for your waiting time.
Risks to Consider: There are very limited risks to selling puts with the intention of buying the stock at the strike price. However, as with any other investment, share prices may keep going lower, resulting in losses even with the cushion of the put premium. Always invest within your risk parameters and know when to close a position before the loss gets too big for your strategy.
Action to Take -- Selling puts to buy the stock at the strike price is a time-tested strategy that works. If you have any questions regarding options, consult the Option Industry Council's website.
This article was originally published Jan. 4, 2013.
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