by Michael Shulman 05/06/08
Oftentimes, you'll hear about a company repurchasing its shares, which is good for investors because it reduces the number of shares outstanding while typically boosting the value of existing shares, as well as the earnings per share.
When PC moguls Bill Gates and Michael Dell wanted to do a share-buyback program for their respective empires, they took advantage of the options markets to increase the return on their investment. What they did was sell (or write) put options, creating a win-win situation with their stock performance.
How does that work? When put contracts are written, if the stock goes down in value, then the shares are "put" to the writer (i.e., to buy from the owner of them). But if the market price spikes, as the person who has shorted the puts, you get to keep the premium you collected when you initiated the position (as "selling to open" an options position oftentimes results in an initial credit to your trading account).
Either way, it's better for the shareholders of a company participating in a buyback because it ultimately means that the company is purchasing its stock back at lower prices, thus increasing the return on the investment for the company and, in turn, its shareholders, because the supply is lower and thus their holdings become more valuable in the marketplace.
Put-writing isn't just for the "big" guys -- you can use this technique to enter into a long stock position. Just keep in mind that when you're selling a put option, you don't expect the stock price to drop below the exercise (or strike) price, nor to increase significantly, either. That way, if the option owner assigns you to buy the stock, you will do so at the strike price of the option.
So, if a stock is trading for $25 and you short a $22.50 put, if the share price dips to $22.50 and the option-holder "puts" that stock to you, then they've saved you the legwork of making the purchase and you're now the owner of the stock you were planning to buy anyway!
In addition to selling puts to establish a long position, you can buy put options to simulate a short stock position. Read more about the flipside of this strategy by clicking here: "Trading Tactics for the Short Side."
What is a Short Stock or Option Position?
Did you know there are several ways you can go short? Well, if you didn't you're not alone. I'll help you count the ways to go short.
Do you think a stock is about to go up? You can buy call options or sell put options, as both indicate that you're making a bullish bet. But how you get from Point A to B is quite different.
Live Well, Thanks to Dying Companies
If you don't want to buy a company's products or services, you shouldn't buy its stocks.
What to Know When Making a Short Trade
Do you know what the trading issues are when shorting a stock? Don't get blindsided with shorting.
Going long, buying puts, selling shorts -- all of these can be confusing at first. But there's hope!
