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You know value investing is a proven way to grow your wealth safely in the stock market for the long term.
But, did you know Warren Buffett uses options in his value investing strategy as well?
Yes, you read it right.
Today, I am going to share with you a very powerful strategy – Value Investing Option Strategy.
What Are Options?
An option is a contract agreement which gives the buyer the right to buy or sell a financial asset at an agreed-upon price. We call this agreed price Strike price.
There are two types of options:
- Call option – it gives the option holder the right to buy at Strike price.
- Put option – it gives the option holder the right to sell at Strike price.
In our value investing option strategy, we are ALWAYS options sellers.
When we sell options, we collect PREMIUM from the option buyer. Premium is the amount of money that the options buyer has to pay to purchase the option. Premium is usually a small percentage of the stock price.
What Is Value Investing Option Strategy?
Value investing is all about buying good businesses for less than its intrinsic value.
When the price of the stock you want to buy is higher than your target buy price, there is a better way than just simply waiting for the stock price to go down to your target buy price.
What if it takes years for the price to go down?
Or what if it does not go down to your target buy price at all?
Instead of doing nothing but waiting, you can use value investing option strategy to make you money in the meantime.
Here’s how it works.
You sell Put options to help you buy your stocks at your target buy price.
If the stock price never goes down to your target buy price, you get paid from selling options month after month.
If the stock price goes down to your target buy price, you get to buy your stock at a price you want and also get the premiums from selling options.
You can still use value investing option strategy after you have bought your stock at your target buy price.
Here’s how it works.
You sell Call option on the stocks you buy and collect premiums.
For your Call option, you pick a Strike price at which you are willing to sell your stocks for a profit.
Before your stock reach your take-profit price, you can continue to make money from selling options.
A Step-By-Step Plan For Value Investing Option Strategy
Step 1: You find good businesses that you want to invest in based on value investing principles.
Step 2: You determine a target price for the stocks that you want to buy. This target price will give you a margin of safety.
Step 3: If the market price is less than your target price, you will buy the stock at market price and sell Call options on the stock. However, if the market price is higher than your target price, you will sell Put options to buy the stock at your target price.
Step 4: If you have already bought the stock, you will keep selling Call options and collect Premiums until the option is exercised. Once the option is exercised, you have to sell the stock to the option holder at the Strike price. This Strike price is picked by you when you sell the options. And this Strike price is the price at which you are willing to sell your stock for a profit.
Step 5: If you are trying to buy the stock, you will keep selling Put options and collect Premiums until the option is exercised. Once the option is exercised, you have to buy the stock from the option holder at the Strike price. This Strike price is picked by you when you sell the options. And the Strike price is the target price for the stock you want to buy.
So, you can see that the main goal is to buy your stock at your target price.
At the same time, you are selling options to collect more money passively while waiting for the stock price to fall below your target price or waiting for the stock price to go above your take-profit price.
The beauty of this value investing option strategy is that you can generate passive income consistently at no additional risk to you.
You are already looking for good stocks to buy based on value investing strategy.
Let say, you are using value investing strategy alone without options.
Value investing strategy is a proven strategy, but there is still risk involved.
When you decide to use value investing strategy, you should be comfortable with the risk that comes with it.
For example, you bought an undervalued stock at $20 per share based on value investing strategy.
The fact that the stock is undervalued does not mean that the stock price will not go down further.
There are always investors who behave irrationally in the stock market.
Yes, it’s already undervalued.
But some people might still sell down the stock out of fear.
So, it does not guarantee to make you a profit immediately after you buy an undervalued stock.
In fact, you could see a paper loss soon after.
That’s the risk you are taking with value investing.
Now, let’s see what happens if you sell options on the stock you have just bought.
There are two scenarios that can happen:
- stock price goes up
- stock price goes down
If the stock price goes down, you make money from selling options. The risk you are taking is the same as when you are only holding the stock and not selling options.
The only difference is that you have more money with the same risk.
If the stock price goes up, you make money from selling options. You also enjoy the same upside as when you are only holding the stock and not selling options.
The only difference is that you have more money with the same upside.
So, if you are doing value investing, you would be leaving money on the table when you are not incorporating options into your strategy.