Bottom Fishing Stocks Using Options
Bottom fishing stocks is a term used to describe a stock purchasing strategy which focuses on shares in a company whose stock has taken a large and decisive price dive accompanied by notably increased volume.
The general idea is that the explosive volume tends to wash out the sellers from the market, leaving it ready for the buyers to come back in and take the share price to higher levels. Hence the term “bottom fishing stocks” – you’re fishing for stocks at what you believe may be the bottom levels of it’s price action and ready for a turnaround.
Buying These Stocks at a Discount
If you know anything about option trading you’ll realize that you can both buy (go long) or sell (go short) option contracts. You’ll also know that in the USA one option contract covers 100 shares while in other countries such as Australia, they cover 1,000 shares – so you’ll need to bear this in mind when it comes to the level of capital you wish to invest. Do you intend to purchase multiples of 100 or 1000 shares?
The best way to illustrate bottom fishing stocks for a discount using options is to take an imaginary example. Let’s say XYZ company stocks have recently fallen dramatically to around $17 on high volume – sometimes referred to as ‘capitulation volume’. The stock has since been trading in a range and you believe it can’t fall much further so it’s a good buy if it goes as far as the $15 price level. You also have sufficient capital to purchase 500 shares.
This is what you do:
You sell 5 put option contracts at a strike price of $15 for expiry next month and also purchase another 5 put option contracts at a lower strike price, same expiry date. This is called a put credit spread, otherwise known as a “bull put spread”. You need the bought position as a kind of insurance protection in case the stock plummets further. You will receive a net credit to your brokerage account. Once this is done, three scenarios can follow:
1. The stock stays around the $17 level by option expiry date. In this case you get to keep the credit you have received and can choose to write another put credit spread for the following month. You have effectively been paid for waiting for the stock to reach your desired level.
2. The stock falls to $15 and you are exercised on your sold options and the stock is put to you. You now own 500 shares of XYZ and can then implement further strategies using options, such as selling covered calls with protected puts.
3. The stock plummets to way below $15. In this case, the stock will be assigned to you, but your bought puts will increase in value and limit your potential losses. You could use the profit from these bought puts to buy more shares and in doing so, average down your entry price as part of a longer term wealth building plan.
Bottom Fishing Stocks Using Inflated Option Prices
One of the reasons bottom fishing stocks is the best time to use this strategy, is that due to the huge stock selloff, the implied volatility in put option prices will normally be high. This means that the near-money options you sell will be at inflated prices, thus bringing you a greater credit for the transaction. You get paid a handsome sum for simply waiting for the stock to fall further – if it does.
Another Huge Advantage
Instead of creating a vertical put credit spread for bottom fishing stocks as outlined above, you could choose instead to make it a diagonal spread. This means that you would sell the near month put option and buy a long dated put option at a lower strike price. You may be exercised on the near month option and own the 500 XYZ shares for a covered call strategy, but you will also now have a long dated put option at a lower strike price over which you can continue to sell more put options each month, or under which you can create a debit spread, bringing you even more income.
Details of this strategy along with so many more powerful secrets about the art of adjustments for option trading profit are outlined in the Trading Pro System.