Placing a Limit Order to Buy 100 ZYX at $45
Selling 1 ZYX 45 Put at $1.50
In this case the investor is committed in advance to a purchase of 100 ZYX shares at $45, below the current level of $48, so he sells the out-of-the-money ZYX 45 put for $1.50 and deposits the purchase price of $4,500 ($45 strike x 100 shares) into his brokerage account in case he's assigned. Consider three possible option expiration scenarios, and compare the outcome of each to the placement of a limit order to buy:
- The stock remains above the $45 strike after the put sale, in which case the investor would not be assigned and not buy 100 ZYX shares
- The stock is below $45 by expiration, in which case the investor can expect to be assigned and obligated to buy the stock at $45
- The stock closes exactly at $45 at expiration
ZYX remains above $45 between put sale and expiration - investor not assigned
Whether by selling a cash-secured $45 put, or by entering a limit order to purchase the stock at $45 per share, the investor will not buy shares and participate in a rise in the price of the ZYX. However, if the investor had sold the $45 put, after expiration he would keep the $150 net premium received. At that point he could either sell another put, or possibly buy the 100 shares outright, at a current price less the $150, if he feels it's a good investment.
ZYX is below $45 at expiration – investor is assigned
Using a limit order to buy ZYX at $45 the investor would see an unrealized loss equal to the amount ZYX stock was below $45 at expiration. By selling the $45 put for $1.50 the investor's net purchase price for the 100 shares is actually lower than his target price of $45: $45 strike - $1.50 premium received = net share price of $43.50. Only below this price, the break-even point for the strategy, would the investor begin to see an unrealized loss on his stock purchase. Should ZYX decline significantly by expiration the investor still has the obligation to buy the stock at $45, whether by limit order or put sale.
ZYX is exactly at $45 at expiration
The investor may be in either situation described above. With a limit order to buy at $45 he may or may not have bought the stock, depending on whether it traded at or below $45 before expiration. If the put was sold instead, the investor may or may not be assigned on this expiring at-the-money put contract, and may not be notified by his brokerage firm until the next business day after expiration. Assigned or not, he retains the put premium received.