Abstract: Describe the reasons of trading short put stock options of Xiaomi, and share the advantages and disadvantages of this strategy.
Today I am sharing with you about the transaction I made last Wednesday (June 6), the detail is as follows:
- Short put
- Xiaomi Corp (HK stock code: 1810)
- 1000 units of stock option
- Expiration: 2021-06-29
- Strike price: HK$27
- Stock price at transaction: HK$28
- Option price: HK$0.52
- Commission fee: HK$19
- Premium received: HK$501
Speaking of stock options, I have had many painful failure lessons. I once lost hundreds of thousands of Hong Kong dollars a night. That happened a few years ago. The way I dealt with stock options at that time was very risky at that time. I am willing to share with you in detail in the future. In recent years, I have rarely done option trading, rather I mainly buy stocks.
Basic types and operations of options
There are too many ways to trade options, and I am afraid I cannot explain them clearly in a short time. Many people have heard of trading stock options, but most of them think it is too complicated to understand, I am planning to write about the operation methods I know about trading options in detail but simple words later, so that hopefully everyone can understand it. Simply put, there are four types: long call, short call, long put and short put. In recent years, I basically only trade short put and covered short call in stock options.
What is short put?
Let me go back to the topic today. What I did was to short put the Xiaomi stock option. May I tell you a little bit about the possible outcomes of trading short put? After the trading session is finished on the expiry date, if the stock price is lower than the strike price of HK$27, I will have to buy 1000 shares of the stock Xiaomi at the strike price HK$27 per share no matter what the stock price becomes, deducting the premium of HK$501 that I received previously, that is, the cost price for me is HK$26.5 per share. Conversely, if the stock price is higher than the strike price after expiration, the option will not be executed and no more risks are there anymore for me and the premiums I received would be the net earning for me in this option transaction.
Correct mentality of trading short put
What I want to add here is that I think the right mentality in doing short put stock options is very critical. By that, I mean first you should be willing to buy this stock at a lower price. By lower price (like HK$26.5 in my case), I mean the price should be lower than that (like HK$28 in my case) at the time when trading the options. However, it is very likely that the stock price may turn out to be way lower than the cost price (HK$26.5) that you pay to buy the stock after expiration, you know, the price may go up or down without any reasons. In that case, you would seem to overpay for the stock. But what you should think is that in my example I was willing to buy its stock at this price level (HK$28). But then, I thought if I can buy at an even lower level (HK$26.5) than that, it would be even better for me. However, you have to prepare to face another situation where if instead the price goes up, say HK$30, it may look like you would have suffered the loss that you might have the chance to buy at HK$28 and so earn HK$2.
Let me do a brief conclusion here first, in doing short put, you should possess the correct mentality as follows:
- Be well prepared to pay the strike price to buy the stock at expiration psychologically and financially, and you should take it easy even if the price goes further down.
- If the stock price does not reach the strike price, that means you might not be able to buy the stock at strike price and in addition the stock price continues to rise, you should not regret it.
The reason why I did short put of Xiaomi
In my situation, I already have a certain amount of Xiaomi stocks in my portfolio. And I wanted to buy more of this stock. Since the stock price of Xiaomi has been rising these days and started to drop a bit last week, I thought it may be time to buy it at this price level, so I used short put to see if I can buy it at a bargained price. Of course, if instead it rises again and causes my option expired and not to be executed, I will be even happier because it will actually increase the value of my portfolio. One of the advantages of using this method to buy in stocks is that you are training yourself to be more disciplined which can really help you avoid buying at the peak.
Risk reward ratio of option premium
Let me teach you little know-how. When we do short call or short put, we want to receive as much premiums as possible. But how much premiums of the option trading is reasonable? In order to reflect it, you can use the calculation by dividing the option price by the executed cost price, in example it is 0.52/(27-0.52), which is about 1.96%. In other words, I use the principal of HK$26480 to bear the risks to earn HK$520, and the risk return is 1.96%. The commission fee is tiny and thus omitted here for the sake of simplicity. It brings 2% return in just 20 days, I think the risk to reward ratio is quite attractive.
Comments and sharing
I am going to finish it here. If you have any questions, please feel free to leave a message or comment below, I will reply you. Or if you find anything incorrect in the article, please let me know and learn from you. If you find it interesting or it may help you in any sense, please share with other people.