Forcing yourself to be a bargain investor

by Wayne Ferbert on September 21st, 2012

At Buy & Hedge, we like buying things at a bargain. For instance, if anyone out there wants to sell me their brand new iPhone 5 for $100, I am listening!
 
But one of the hardest things to do psychologically as an investor is purchase a stock or ETF while it is in the middle of a decline. The decline truly tests how much of a ‘bargain’ you really thought that stock was.
 
You might remember that when FaceBook (FB) had its IPO, we said we’d be interested in buying it if it went down to the $20 to $21 range. You can read that blog here.
 
So some folks have asked us if we now own it since it dropped all the way down to an $17+ handle. The answer is: No. We saw that its momentum was going to make it drop well under $21 so we waited. But then we missed our opportunity. We didn’t buy in around the $17.55 lows. And today it is trading at just under $23.
 
So, we didn’t follow the discipline and force ourselves to be buyers at $21 – even though we’d be happy today to have bought in to FaceBook at $21.
 
So, how can we remedy this? We can use options to create a ‘buying program’ for FaceBook. The buying program involves selling puts at the $20 price for FaceBook that expire in the near month. Then, if FaceBook dips to that price, we will get assigned and be forced to buy it at that strike price (ie, the $20 price).
 
Had we implemented this buying program using options originally at the $20 price, we’d already own FB at that price.
 
If you look at the October expirations for FaceBook, you’ll see the puts at the $20 strike are trading at a mark of 35 cents. So, you’ll collect about 35 cents to be a ‘forced’ buyer of FaceBook at $20 price if it trades below that price between now and the October expiration.
 
The October expiration is one month away. The 35 cents premium on a $23 stock is a 1.5% premium you get PAID to be a forced owner of FaceBook if it trades lower. I like that payment for one month. It is certainly commensurate with the risk of FaceBook given the high volatility in that stock price.
 
FaceBook is expected to announce earnings on October 23rd – which is 3 days after those options will expire. So, this strategy will not involve the risk of an earnings announcement surprise.
 
Then, after earnings are announced on that date, you can re-assess the premiums in the options market and the FaceBook price and see if you want to continue the ‘buying program’ we are considering here.
 
Note that this strategy can be used for any stock or ETF that is starting to approach a ‘bargain’ level in your eyes. I like this program because you get paid a monthly premium for being willing to be a buyer of a stock or ETF that you think is a bargain ANYWAY! Who doesn’t like being paid to be a bargain shopper! Seems like good work if you can get it!



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