By Sham Gad Updated Jul 8, If there is one lesson that investors should learn from market history over the past several decades, it is that the best time to buy stocks is when the market is tanking.
Unfortunately, very few have the conviction to buy in the middle of a wave of panic selling. If making a complete commitment to buy is not in the cards for you, then one option strategy—selling puts—provides an alternative. Selling puts may actually be easier for the individual investor to stomach. Options working strategy Takeaways Historically, buying stocks during a downturn has been very profitable, but many investors just can't do it.
Selling put options during a downturn is a options working strategy alternative to buying stocks. The high volatility of bear markets makes selling options more profitable than usual. Less experienced investors should only sell puts on stocks that they would be comfortable owning.
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Buying in a Downturn Market history suggests that a contrarian approach works better. After the bear market in the early s, buyers were rewarded.
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Investors made lasting gains by buying during a severe recession in the early s. After the financial crisis ofstock buyers won big over the next decade. Within months of the crash ofmany investors made record gains in record time. Fifty years from now, the story is likely to be the same. Basics of Put Options A put option gives the buyer of that option the right to sell a stock at a predetermined price known as the option strike price.
Buyers of put options are making bearish bets against the underlying company. The price you would pay for options working strategy put option will be determined, among other things, by the length of time you want the option to last. The longer the time, the more options working strategy pay. When selling put options, the reverse is true. A seller of put options is taking on the obligation to buy the underlying stock at a predetermined price.
Notice the difference in buying and selling puts: when you buy a put, you have the right to sell the option.
When you sell a put, you are required to buy the shares if the buyer of the puts decides to sell them. So in selling put options, the risk is magnified only in one sense. You are entering into a contract where you have an obligation, rather than a right to buy the stock.
This information should be well-known to investors who have studied options basics. Put Selling in a Downturn When markets are declining, selling put options can be an excellent tool even for the individual investor. However, one must know how to sell puts intelligently.
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When stock prices fall, they often do so rather quickly. That leads to an increase in volatilitywhich in turn increases option premiums. This increase options working strategy sense because options face time decayso having a stock price that moves quickly is what option traders want.
Selling options when there is more volatility implies that sellers will get a higher price due to the increased premiums. Sophisticated options traders like to sell puts in hopes of pocketing the premium income. However, long-term investors should look at selling put options as a way to buy shares in businesses that they like at a lower cost.
Legendary investor Warren Buffett has used similar strategies in the past. The best time to buy stocks is when markets are declining. Yet many investors simply don't have the emotional wherewithal to do so. Selling puts is one way to alleviate the problem. You would like to own shares in your portfolio. For options working strategy of this article, we will ignore commissions because they are often low, although they should still be considered.
Drawbacks Of course, selling puts is not a sure thing. If shares in XYZ or any company that you sell put options on decline significantly, you will still be sitting on losses. Option premiums will just reduce the losses. Conversely, suppose the stock price continues to go up.
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Then, the put seller will miss out on further upside that could have been achieved above and beyond the option premium. Selling Puts Intelligently Because they are derivative instruments, the buying and selling of options should be handled with extra care.
The sale of a put firmly obligates you to buy the underlying stock, so only sell puts on stocks that you would be comfortable owning. Some plans include the seagull option strategy.
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For the vast majority of investors, selling puts should only be considered as a way of potentially buying shares down the road. Let earning the option premium be a fallback if you don't get a chance to buy the stock for less.
This type of thinking will significantly reduce the probability of selling puts for the wrong reasons and losing money. Article Sources Investopedia requires writers to use primary sources to support their work.
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