Buying Stock Using Stock Options

Buying Stock Using Stock Options

When long-term investors want to buy shares of a stock, they often pay the price that is currently being offered on the market for those shares. By utilizing stock options, however, it is possible to acquire shares without having to pay the current market price for them. By learning about options and how to buy them, you can add another tool to your collection of ways to invest.

Key Takeaways

  • You are able to purchase shares of a company’s stock without having to pay the current market price if you have stock options.
  • A stock option is a contract that gives the buyer the right to buy (also called “calling”) or sell (also called “putting”) the underlying shares at a set price and by a set date.
  • There are stock options available on almost all individual equities in the United States, Europe, and Asia, and there are a number of reasons why you might want to make use of them.

Call options and put options

A contract known as a stock option grants the buyer the right, but not the responsibility, to acquire or sell interest at a predetermined price on or before a predetermined date. However, the buyer is not required to exercise this right. The option that gives you the ability to buy a stock is referred to as a “call” option, and the option that gives you the ability to sell a stock is referred to as a “put” option. If you don’t use the right contract given to you before the expiration date, your option will be worthless and you’ll have to pay back the premium, which is the amount of money you paid to get the option.

Options on stocks can be purchased for the vast majority of individual equities traded in the United States, Europe, and Asia. You should be aware that in addition to the possibilities that were just mentioned as being in the American style, there are additional options that are in the European style. They are distinct from those used in the United States in that the option to use them can only be exercised on the day of expiration and not in the period preceding up to that date.

How to Make a Profit Using Put Options to Invest in Stocks

Selling put options on one hundred shares of a particular stock is one method that can be utilized to bring down the overall cost of purchasing the stock in question. The person who purchases your options will have the “strike price” right, which gives them the ability to sell you the underlying shares at a predetermined price. 

It’s possible that new traders and investors won’t have access to the opportunity to purchase and sell options within their trading platform. Before making an investment, it is important to think about the platforms that offer the best opportunities for trading options and to conduct adequate research.

After deciding on a stock that you feel would be beneficial for you to own at a particular strike price, there are a few steps that you may take in order to try to engage in the typical sort of options trading. These processes are as follows:

  • You should try to sell one put option that is out of the money for every 100 shares of stock that you want to buy. When the current price of the underlying stock is greater than the strike price of the put option, the option is considered to be “out of the money.”
  • Wait for the price of the stock to drop until it reaches the strike price of the put options.
  • You should make a purchase of the underlying shares at the strike price if the options are issued by the options exchange.
  • If the options are not assigned, the money gained from selling the put options is yours to keep as the premium.

The Positives of Having Options

When it comes to purchasing shares, utilizing this stock option approach offers you three primary benefits:

When you sell put options, you are entitled to receive the premiums as soon as they are settled. If the price of the underlying stock never falls below the strike price of the put options, then you won’t be able to buy the shares you wanted to, but at least you’ll get to keep the money from the premiums you paid. 

If the price of the underlying stock drops to the strike price of the put options, then you will be able to buy the shares at the strike price rather than at the higher market price that was previously in effect. Because it is up to you to decide which put options to sell, you have complete control over the strike price and, as a result, the price at which you purchase the underlying stock. 

The premium that you were given for the put options acts as a slight buffer between the purchase price of the stock and the point at which the trade is considered profitable. This indicates that the share price will need to drop a little bit more before the trade will result in a loss of money.

A specific case study of a trade

Let’s say that a stock investor with a long-term perspective has settled on the decision to purchase shares in QRS Inc. The price of a share of QRS stock is currently $430, and the next time those options will expire will be in one month. The investor has decided to make the following stock option deal in order to fulfill their goal of purchasing 1,000 shares of QRS:

Sell ten put options with a strike price of $420 and a premium of $7 per option contract. Each option contract represents 100 shares of the underlying security. The maximum return that might be obtained from this transaction is equal to $7,000 ($7 times 10 times 100). The investor will be paid the sum of $7,000 once more investors have bought the options.

The investor is waiting to see if the price of QRS stock will drop to the $420 strike price that is associated with the put options. It is possible for the put options to be executed and for the exchange to assign the put options if the stock price falls to 420 dollars a share. If the put options are assigned to the investor, the investor will be required to acquire QRS stock at the strike price of $420 per share. This was the price that the investor chose when they sold the put options.

In the event that the put options are executed and the investor buys the underlying stock, the $7,000 that is received for the put options will serve as a tiny cushion against the possibility that this stock transaction may result in a loss. The buffer will be seven dollars per share, which is calculated by dividing the profit from selling the puts ($7,000) by the total number of shares (1,000). This indicates that the investor will be profitable whenever the price of the stock reaches $413. If the price of the stock falls below $413, the investment in the stock will be considered a losing trade.

If the share price of QRS does not fall to the $420 strike price of the put options, then the put options will not be exercised, and the investor will not be able to acquire the stock that is underlying the put options. Instead, the investor is going to keep the $7,000 that they received from selling the put options.

Questions That Are Typically Asked (FAQs)

How is taxation handled for stock options?

Stock options are taxed like stocks. Any gains you make will be subject to taxation at the standard rate applicable to your income, unless you have held the option for more than a year, in which case you may be eligible for a reduced rate applicable to long-term capital gains. Because the method described here involves selling the option instead of buying and keeping it, the transaction will be seen as short-term and will be taxed at the same rate as your regular income.

When do the stock options become null and void?

Every possibility is accompanied by a distinct termination date (usually a Friday, though it can be any day). It is possible to exercise an American-style option at any moment up until the end of the expiration period. This type of option is typical for equity options sold in the United States. European-style options, such as those on U.S. stock indexes, can only be used at the end of their term.

Leave a Reply