Tue Jun 27, 2006: Buying Stock at a Discount with Naked Puts (MRVL)

Shares of Marvell Technology Group (NASDAQ-MRVL) have fallen from their Jan 27th high above 70 to today's closing price of 44.14. Is this the bottom?

Potential buyers interested in using options to gain a price advantage might consider selling naked (cash-covered) puts now to possibly buy the stock at a discount to even the current low price.

A "cash-covered" put means you set aside enough money in your account to pay for the stock, but rather than purchase it outright you sell put options. This obligates you to buy the stock only if it falls further, below the strike price. It also gives you some income even if the stock doesn't go down any more.

For example the table below highlights in blue the option income available from selling August 42.50 puts on MRVL at a price of $260 per contract. The option yield, assuming the stock closes on expiration day August 18th anywhere above the strike price, would be 6.5%, a decent return on your money for less than two months. If the stock closes below 42.50 then 100 shares per option contract would be "put" to you at $42.50. That is, your broker would automatically buy the stock for you in your account at that strike price to satisfy the terms of the option contract.

In that case, since you still get to keep the $2.60 per share income, your net cost would be only $39.90 per share, so you would end up buying it at a substantial discount to today's price.

Investors who write cash-covered puts are trying to buy stocks either at a discount or not at all, receiving a steady income from the options regardless of what happens to the stock price. So this is a more conservative approach than simply buying stocks outright.

It does require patience and a willingness to deal with the uncertainty of not knowing until expiration Friday each month which stocks you will actually buy. However since you can always sell another round of put options the next month for the ones that expire worthless, this strategy can prove quite profitable over the long run.

Until next time, best of luck with your option investments!