You are about to write a limited buy order on a very liquid stock. Imagine what your stock broker might do.
Stock ABC has recently weakened a little towards your target buying range. You may enter a limited buy order for 100 ABC at €50. Alternatively you may issue a short duration put option with strike price €50. With a few weeks to go till expiration, issuing the put option may bring in little over €50. This is what your stockbroker might earn when applying this strategy when you just enter your limited buy order.
Basicly three things can happen, in any case the €50 option premium collected is yours.
Stock ABC dips further below €50 intraday. Now your limit order would have been filled at €50. The notional value of your issued put option will have increased, since this derivative now is ‘in the money’. Yet this is of little concern to you, since you plan to take delivery. There are two scenarios here:
1 a) stock ABC still quotes below your limit at the option expiry: you will get delivery of your 100 shares ABC. Eventually you pay €5000 – €50 (your collected option premium).
1 b) stock ABC strengthens again and ends above your limit on the option expiry day: too bad you don’t get your expected 100 shares of ABC.
Stock ABC never even touched down to your limit price; only one outcome:
2) Your entered limit order would have finished void and so does the put option issued.
Issuing a put order requests discipline:
When entering a limited buy order, you may alter the limit price at will, while no execution has taken place. No place for dancing around the hot broth after you have issued a put and collected the premium.
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