How to Buy Stocks, Priceline-Style

By Carlos Portocarrero on 1 December 2010 (Updated 16 December 2010) 5 comments

When Priceline burst onto the scene in 1998, it stood out because it offered would-be travelers a new, cheap way to book airline tickets.

By allowing users to name their own prices, Priceline turned the online-travel world upside down. Instead of scouring the web trying to find the best price, you could set your own price for a flight, cross your fingers, and hope you’d get “filled” at that price.

People loved the idea of being able to set their own price for something as expensive as a plane ticket.

But can this model work in other parts of life, like buying and selling stocks? Say a stock you love is priced at $25, but you want to buy it at $20. Wouldn’t it be great if you could put in an order at $20 and have it filled if the price dipped down to that level?

That’s possible — it’s called a limit order, and it basically says “buy this stock if/when it hits $20.” But if it takes months or years for the stock to come down, you’re wasting valuable time. Plus it’s boring.

Enter options.

Options allow you to make the same trade with one exception: You can make money each month that the stock doesn’t hit your price. You’ll still have to wait for the price to come down, but you’ll get paid while you wait.

It’s like Priceline sending you a check for $30 every month that they can’t find you a flight to LA at your $500 price.

The downside, of course, is that you never know when you’ll get to go to LA. You might never go because the price may not fall that low, but at least you’ll get paid to wait.

That’s how the "cash-secured put" strategy works — you name your own price, and you get paid while you wait. There are a bunch of other options strategies out there, but this one is a personal favorite.

For investors looking to buy a stock at a specific (lower) price, the cash-secured put is a popular way to use one of the advantages of options to make a stock trade.

If you want to test out a cash-secured put or any other options strategy, a great way to go about it, especially for beginners, it is to try it in a virtual trading account. Online brokers like OptionsHouse* offer virtual trading free of charge. In a virtual account, you are able to try trading with real stocks and prices, but with virtual dollars. Once you’ve learned the ropes and gained the confidence, you can try the cash-secured put for real.

One thing to remember: The “cash-secured” part implies that you’ve got the money available to buy the stock at the discount price you want.  If you are waiting for that stock to hit $20, and you’d like to buy 100 shares, you’d need to set aside $2,000 for if/when the stock hits your target price.

If you do wind up owning the stock, you’ll take on the same risks as owning any other stock — gains are unlimited if the shares rally, but the stock can also go down to zero. 

Think of the cash-secured put as the “Priceline of options strategies,” without the William Shatner endorsement. 

* Disclaimer: I am an employee of OptionsHouse and do not have a position in or endorse Priceline as a company or a stock. The views and opinions expressed on this post are mine and do not necessarily reflect the views of OptionsHouse, LLC or any of its affiliated companies. Check out more cash-secured put examples on the OptionsHouse blog.

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Guest's picture
Miguel

excellent tip Carlos. I have thought about doing this several times with my online broker. You can set a price and how many shares you want at that price when it hits. I think investors should be careful as well when they do this because there is a possibility you can forget you even put a limit order on a stock and you end up buying another stock. So when that limit order is ready to go, there isn't enough funds to fulfill your order, thus missing out on your opportunity. I think discount brokers online have already found a way to avoid this for you though.

Carlos Portocarrero's picture

@Miguel: What you're talking about is a limit order, and in that case you're right—you need to make sure you still have the money to buy that stock after making another purchase.

But the article is about how you can name your own price by using options, namely the cash-secured put. It's kind of like the limit order only that you collect a premium every month that you wait for the stock to come down to the price you want to pay.

Guest's picture
Former Broker

This is a shameless article. The average person should NOT trade options. All readers of this post should know that OptionsHouse and other options brokers make money off of each and every option you trade. They have a huge incentive to encourage as much active trading as possible. Encouraging people to gamble their money with options on this website is outrageous.

TD Ameritrade, OptionsHouse, thinkorswim (acquired by TD), and other brokers are EXCELLENT salesmen. They make it sound like the stock and options markets are easily understood and that the average Joe can easily make money with all of their wonderful tools. This is so shameless and self-serving it makes me sick. This is one of the reasons I quit the financial industry. Please do NOT listen to people selling you Active Trading or Options. A balanced portfolio of INDEX Funds is safe, cheap, and doesn't require you to pay massive commissions (like Options do) and can limit risk. Talk to customer-owned companies like Vanguard or invest in your 401k plan at work in a low-fee fund.

Carlos, you know better than this. If you don't know better, you haven't been doing it very long.

Carlos Portocarrero's picture

Former Broker: I think your comment is extremely one sided.

Options may not be for everyone, but anyone who trades stocks would be well served to learn how options work and the basics behind them. They are really just another tool that can be used to express a sentiment about a company/stock.

And of course brokers make money off each option trade! They’re a business and their goal is to perform a service and attempt to turn a profit while doing it.

Options can be used responsible and irresponsibly—just like anything else. But the goal of the article was to show stock investors how they can use options not to gamble but to execute a trade that takes advantage of some of the benefits of options.

As for index funds, I’m a huge fan. I think index funds are a good fit for some investors, especially when it comes to long-term investing in a Roth IRA or 401(k). But I think that scaring people away from learning about options is a disservice to them. Learning about them makes for a more well rounded, prepared investor.

At OptionsHouse, we make every effort to educate our customers on potentially risky investments like triple-leveraged ETFs and how to manage some options-trading risks.

Guest's picture
DubyaT

This is a good way to save a couple of dollars and miss some golden opportunities. What's the phrase, penny wise and pound foolish?