A Microsoft Stock question today from a reader on yesterday’s article got me thinking about when to buy put options. My goal for the Microsoft stock put selling was to sell puts in small groups as Microsoft Stock pulled back. I was of the belief that Microsoft Stock was ready to pull back although I have to admit I was reading a lot into the fast stochastic and perhaps some of it was just wishful thinking on my part. You can read my Microsoft stock article here and you can read my second outlook after today’s big run up, here.
Microsoft Stock Reader’s Question
If what you predict (Microsoft stock pulling back toward support) is going to happen, why not just buy the $30 and $32.5 (strike) put (options) going out 2-5 months. This would seem to make more sense. Thanks
When Buying Put Options Makes More Sense
In my article I discussed the support range for Microsoft Stock over the past 1 and 3 years. Below is the one year Microsoft Stock chart. The problem with buying put options is that if the stock ends up not declining, the put option will expire worthless and capital will have been lost.
Microsoft Stock Buying Put Options
While my reading of the fast stochastic from yesterday lead me to believe that Microsoft Stock might be on the verge of a pullback toward support at $28 and then possibly $26 following the news of their Surface, Tablet, there is never a guarantee that the stock will behave as I expect.
Indeed the technical timing indicators for yesterday (see below) did not actually show that Microsoft stock was going to decline. It was a guess on my part, based on the fast stochastic. Basically I was hoping to have picked the start of a decline in the stock. I sold a handful of puts into July and August but I was hoping for the stock to decline further.
However without a confirmed sell signal in any stock I would never buy put options to try to profit on the way down.
Microsoft Stock Sell Signal For Buying Put Options
When buying put options you should be buying when a sell signal is issued by your technical timing tools. A good tool for such a sell signal is MACD or Moving Average Convergence / Divergence.
In the chart below you can see the sell signals in Microsoft Stock from MACD. These would be opportune moments to buy put options to profit from the decline in the stock. You can see below the two sell signals from MACD since March 2012.
You can also see in this same chart a buy signal from June 8. When I made my prediction of a decline in Microsoft Stock, there was no sell signal. Indeed, a buy signal had been issued on June 8 2012 just a few trading sessions earlier so without a confirmed sell signal, it is a gamble whether I was right with my outlook for Microsoft stock to pull back. In investing I never gamble and buying puts is a gamble that the stock direction will be right. With put selling I can still be wrong and yet profit from my trade.
Microsoft Stock Advantages Of Put Selling
Put selling has a number of advantages over buying put options. As options are a wasting asset, I will benefit both from the eroding time to options expiry as well as Microsoft stock staying above my sold put strikes.
Further, with put selling I can still generate some income even if the stock does not perform as expected. In other words should the stock not follow my best guess and instead of falling, climb, my put options are still profiting my portfolio.
The advantages of selling smaller groups of put options outweighs buying put options. Yesterday for example I sold 5 naked puts for $28 strike into July and 5 naked puts for $27 strike into August. If I had been right and Microsoft Stock had fallen, I was still able to sell further put options to take advantage of the decline in the stock and the higher put premiums.
On the other hand if Microsoft Stock rose, my put options previously sold are still profiting my position.
When buying put options, the stock must decline in order for my put options to profit my portfolio, otherwise I will lose capital as options are a wasting asset and in particular if the stock should climb. Since I am willing to accept shares should the stock not climb, put selling holds tremendous benefits over buying put options.
Put Selling Versus Buying Puts On Microsoft Stock Summary
Put selling gives me the advantage of still profiting when I am wrong in the underlying direction. By put selling small groups I can take advantage of declines by selling more puts and earning higher premiums. If wrong and Microsoft stock climbs, I am still benefiting from the small groups of put options sold. I look at put selling against a stock such as Microsoft stock as a win-win situation.