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Chapter 6. Alternatives to Stock Purchase > Short Puts and Contingent Purchase

Short Puts and Contingent Purchase

You are not limited to long LEAPS calls to enter a contingent-purchase strategy. You can also use short puts. When you sell puts, you are required by your brokerage firm to have adequate funds on deposit to satisfy exercise of the put, if and when that occurs. The benefit of the put strategy is that money flows to you rather than away from you. Time value is also an advantage. You receive a premium for selling the put, and that premium value declines over time, even when the stock's value falls to in-the-money price levels. Time value may offset intrinsic value to a degree.

Using the same stocks as examples for reviewing long-call strategies, we can use puts to set up a short-position contingent purchase. We begin with a review of the strike price. If you would be happy to acquire shares at that price, based on the fundamentals, then the short-put is an excellent strategy. It can go in one of two possible directions. First, the stock does not move in the money, in which case you can later buy the puts to close at a profit or allow them to expire. Second, the stock's market value declines below strike price; in this event, you can either wait for exercise or roll forward and down to avoid or defer exercise. When you roll forward and down, you expose yourself to more time, but you reduce the basis in the event of later exercise by one strike price increment.


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