Really? I Get Paid While Waiting?

We have studied common behavioral mistakes in Finance and Investments during the last five issues, starting with "Why Do You Make Bad Financial Decisions?" Read all past issues here. 

We'll take a break to study options and resume our series later. 

My friend Boogie (not his real name) was lamenting that he missed the opportunity to buy stocks of NVIDIA Corp. six months ago, back in November 2023, when NVDA was still trading at $435.06 per share. Yesterday, April 12, 2024, NVDA closed at $881.86, representing a gain of 202%. He had $50,000 to invest but was too busy at work and failed to pull the trigger and buy the stock. Had he bought the stock, he would've bought 114 shares for $49,596.84 ($435.06 x 114 shares) and now would be worth $100,532.04 (881.86 x 114 shares), more than doubling his investment.

Boogie has since increased his budget to $65,000 and remains keen on NVDA. He says that NVDA is the "Godfather of AI," AI will be a secular trend that's just getting started and will be bigger than the internet itself. He wants to "buy and hold" the stock long-term for at least two years because he believes it has more room to run. However, he insists he will buy it only for at least a 30% discount, approximately $617 per share, and he is willing to wait three months for the price to come down.

He sent his broker a LIMIT order to BUY 100 shares of NVDA for, at most, $615 per share. The order is a GTC (Good-Til-Canceled) order and will remain active until Boogie explicitly takes action to cancel the order. He is willing to wait three months and then cancel the GTC order.

Assuming NVDA is a good investment, what do you think of his play? It is possible that NVDA keeps going up and never goes back to $615 per share; Boogie loses because (1) he didn't get to buy the stock, and (2) he uselessly tied up his $61,500 capital. Can we use options to make a better play? 

Consider the "NVDA July 19 '24 PUT 615 at $7.07" PUT option contract with a $7.07 premium. Since an option contract controls 100 shares, this contract is selling for $707 ($7.07 premium x 100 shares). When Boogie sells this, he will receive $707 in income. If the market price of NVDA is lower than the $615 strike price on the July 19, 2024 expiration date (which is Boogie's three-month timeframe), the PUT buyer is guaranteed to sell 100 NVDA shares at $615 per share, and Boogie commits to buying them; it is what Boogie wants: he buys NVDA shares for a 30% discount and receives a $707 income to boot!

Boogie sold what is known as a NAKED PUT, also known as a CASH SECURED PUT. Many would say that NAKED PUTs are one of the riskiest option plays. However, a NAKED PUT is perfect in this particular context because Boogie is determined to buy 100 NVDA shares at $615. You might say, what if NVDA goes even lower than $615? That has nothing to do with whether Boogie used options or not. In any case, Boogie plans to hold the stock long-term, and the price drop is probably just noise and doesn't matter.

Let me know if you have questions or comments. Please email me at [email protected].