Tyler Craig: Limit orders have long been used to strategically acquire shares of stock at a desired price. They give traders a great deal of control over how and when their order is filled. Want to accumulate shares of the iShares Silver ETF (NYSE:SLV) when/if it drops to $30? Input a buy limit order for $30. In the event SLV drops below this line in the sand your order will be filled. While the order guarantees your order won’t be filled one iota above $30, it doesn’t guarantee you will buy the stock. In the event SLV remains above $30 your order will sit unfilled leaving you to watch any future upside action in SLV from the sidelines.
Short puts offer an intriguing alternative to placing limit orders below a current stock price. Like a limit order they put traders in a position to buy shares of stock at a specific price. In the event the stock remains above that price traders won’t have to buy shares of stock. The beauty of a short put over the limit order, however, is the ability to capture some type of profit even if the stock doesn’t fall to your desired buy price. It’s as if someone is paying you to obligate yourself to buy the stock at a discount to current prices. If you’re a willing buyer already the extra premium is simply icing on the cake.
Take SLV for example. If you’re a willing buyer at $30, instead of placing a limit order at that threshold how about selling a June 30 put option for around $.75. If SLV continues to slide and sits below $30 at June expiration you will purchase shares of stock at a cost basis of $32.25 (30-.75). If SLV fails to drop all the way to $30 by June expiration you will not purchase shares but will pocket the $.75 as a consolation prize.
As I see it there are two primary differences of note. First, the short put requires you to allocate capital to the positions immediately. Your broker will require you to hold aside margin to cover the risk of the short put option. Such is not the case with limit orders. Second, the limit order will effectively get you long shares of SLV whenever it falls below the $30 level. The short 30 put only allows you to accumulate shares of SLV if it sits below $30 at June expiration (unless assigned early).
If you’re an active user of limit orders consider adding short puts to the mix to acquire some of the aforementioned benefits.
ABOUT:Tyler Craig, author of Tyler’s Trading and owner of TC Trading, Inc. Over the years I’ve educated hundreds of traders through my work with one of the nation’s leading educational firms. I enjoy writing and am a current monthly contributor to the Wealth Intelligence Magazine. My writings have also been featured in Expiring Monthly and frequently show up in the Abnormal Returns Options Newsletter. In 2009 I started Tyler’s Trading to share daily market commentary on stocks and options.