John Jagerson

How to Buy Stocks at a Discount

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This article is brought to you by LearningMarkets.com.

Option traders have an advantage over stock traders because, when the timing is right, they can buy stocks at a discount. How do they do it? They sell put options on stocks they want to own and then wait for the price to fall. Sound complicated?

Surprisingly, it's quite simple once you understand the basics. Let's start from the top and take a look at the first step you need to take to start putting this strategy to use in your own portfolio.

Step 1: Find a Stock You Want to Own

The first step to take when looking to buy stocks by selling puts is to find a stock that you would like to own. After all, in the end when you employ this strategy, you are hoping to own the stock as a part of your portfolio. And since you wouldn't just go out and buy any old stock in a standard stock trade, you shouldn't just settle for any old stock when implementing this strategy.

This may seem obvious, but when we get into the next step, you will see that if you don't start with Step 1, it is easy to be tempted to simply sell puts on the stocks that are offering the highest premium–which can be a big mistake.

When you're looking for stocks you would like to own, make sure you look for stocks with strong fundamentals–especially in turbulent markets because they have a good chance of rebounding faster than other stocks.

Step 2: Sell Put Options

Your next step to buying stocks at a discount is identifying which put option you are going to sell and then selling it. As an option seller, you have three choices when looking at which put option to sell. You can sell the at-the-money option, an out-of-the money option or an in-the-money option.

When selling puts to buy stocks, you are typically going to use an at-the-money put option. At-the-money options offer a nice balance between paying a good premium and giving you a good chance of actually having the stock put to you.

The premium you receive for selling the put option directly impacts the discount you will get on your stock purchase if the stock is put to you. The higher the premium, the better the discount. As I mentioned above, some stocks offer extremely high premiums on their put options either because the stocks are extremely volatile or everybody believes the stock is going to be moving lower. If you haven't done your homework and determined that the stock is one you would want to own, you may be tempted to go for the stock with the highest premium.