Bottom Fishing Stocks Using Options

Bottom fishing stocks is a term used to explain a stock buying method which focuses on shares in a company whose stock has experienced a significant and decisive price dive in conjunction with notably increased volume.

The general assumption is that the explosive volume tends to wash the sellers out of the market, leaving it ready for the buyers to return and bid up the share price to higher levels. Hence the term "bottom fishing stocks" - you're trawling for stocks at what you consider will likely be the bottom levels of it's price action and well positioned for a turnaround.

Buying These Stocks at a Discount

If you have learned about option trading you'll recognize that you can both buy (go long) or sell (go short) option contracts. You'll also know that in the united states one option contract covers 100 shares while in other countries such as Australia, they cover 1,000 shares - so you'll need to take this into account when it comes to how much capital you want to invest. Do you intend to purchase multiples of 100 or 1000 shares?

The simplest way to illustrate bottom fishing stocks for a discount using options is to create our own imaginary example. Let's say XYZ company stocks have recently dropped significantly to around $17 on large volume - sometimes labeled as 'capitulation volume'. The stock has since been trading in a price range and you believe it can't fall much further so it will still be value for money if it goes as far as the $15 price level. You also have sufficient capital to acquire 500 shares.

This is what you do:

You sell 5 put option contracts with a strike price of $15 for expiry the following month and in addition purchase an additional 5 put option contracts for a lower exercise price, same expiry date. This is called a put credit spread, also known as a "bull put spread". You'll need the bought position as a form of insurance safeguard in case the stock plummets even further. You will be given a net credit to your brokerage account. Once this is done, three scenarios can follow:

1. The stock remains around the $17 level by option expiry date. In this instance you get to keep the credit you've been given and can elect to sell another put credit spread for the following month. You have effectively been paid for waiting for the stock to reach your desired level.

2. The stock falls to $15 and you are exercised on your sold options so that the stock is put to you. You now own 500 shares of XYZ and can then implement further strategies using options, for instance selling covered calls with protected puts.

3. The stock continues its decline to way below $15. In this case, the stock will be assigned to you, but your bought puts will increase in value and limit your potential losses. You could use the profit from these bought puts to acquire more shares and in doing so, average down your entry price as part of a longer term wealth building plan.

Bottom Fishing Stocks Using Inflated Option Prices

One reason bottom fishing stocks is the best time to use this strategy, is that as a result of the huge stock selloff, the implied volatility in put option prices will usually be elevated. Consequently the near-money options you sell will be at inflated prices, thus furnishing you with an even greater credit for the transaction. You receive a handsome sum for simply waiting for the stock to fall further - if it does.

Owen has traded options for many years and is writes for "Options Trading Mastery" - a popular site which explores the best option trading systems. Discover some great Option Trading Strategies here and empower yourself for trading success!