How You Can Buy Stocks on Layaway

As stocks have moved lower throughout 2008, many have sought out ways to capitalize on what they see as the best investing opportunity they're likely to get in their lifetimes. Yet if you're a bit cash-poor at the moment, you may think you'll miss out on the best bargains if a rally comes before you're ready to buy.

Fortunately, however, there's a low-cost way to put stocks on layaway, letting you put off having to pay for shares until you have enough money to buy them outright. And although this technique involves using a type of investment that most people associated with more risky investing strategies, it's easy to define the risks involved with the technique -- and to limit your risk to the exact level you're comfortable with.

Getting in-the-money
When you buy a call option, you get the right to buy stock for a certain price (known as the strike price) with a set period of time. So for instance, if you buy a January 20 call with a strike price of $20, you can put down $2,000 anytime between now and the third Friday of January and get 100 shares of the stock you select, no matter what its price happens to be when you decide to exercise your option.

Now typically, many investors use options as a way to make a leveraged bet on a stock. By buying call options whose strike price is above the current market price for shares, they speculate that the stock will move higher before their option expires, earning them a profit. These out-of-the-money call options are relatively inexpensive, but they also bear a fair amount of risk -- if the stock price doesn't rise before your options expire, then you'll lose the entire amount you paid for them.

Yet while most options activity occurs at strike prices near or above the current stock price, you can also buy in-the-money call options. These options have strike prices that are below the current share price. And while they're not particularly good for investors seeking leverage, they're a great tool for investors looking to lock in current prices for stocks until they get all the cash they need to buy shares outright.

How it works
The reason in-the-money call options work well to put stocks on layaway is that they're not marked up very far from the intrinsic value. Consider, for instance, some option prices on these commonly traded stocks:

Stock

Share Price

In-The-Money Option

Recent Option Price

Markup From Intrinsic Value

Intel (Nasdaq: INTC  )

14.23

January 10

4.25

0.02

Apple (Nasdaq: AAPL  )

85.04

January 60

25.18

0.14

AT&T (NYSE: T  )

27.83

July 20

8.65

0.82

ExxonMobil (NYSE: XOM  )

75.78

February 60

16.50

0.72

McDonald's (NYSE: MCD  )

61.28

March 50

11.50

0.22

Procter & Gamble (NYSE: PG  )

60.39

January 45

15.50

0.11

Valero Energy (NYSE: VLO  )

20.49

March 15

6.10

0.61

Source: CBOE.com. Stock and option prices as of Dec. 24 close.

To learn more about how to calculate intrinsic value, you need to look at what would happen if you exercised the option immediately after you purchased it. For instance, look at the Intel option above. The $4.25 price quoted above means you'd pay $425 for an option to buy 100 shares of Intel at $10 per share. If you immediately exercised that option, you'd pay $1,000 and get 100 shares of Intel. In total, you would have spent $1,425. That's just $2 more than you would have paid to buy Intel shares at the current market price -- but you earned yourself the right to wait until mid-January to pay for the shares.

There's one important catch, however. Call options give you the right to buy shares, but they don't give you the right to dividends on those shares until you actually exercise the option. So if a stock pays a dividend before you exercise the option, you won't get it, whereas if you'd bought the stock on day 1, you would. So you may want to add that missed dividend to the total cost of using the strategy if you intend to use most or all of the time your option gives you before you exercise it.

In general, the more you're willing to pay for the option up front and the sooner you commit to exercising, the less markup you'll pay. But for many stocks, you can buy options that will give you several years before you have to come up with money to exercise.

So if you're looking to lock in today's low prices on stocks but won't have all the cash you need until sometime in the future, consider in-the-money call options. They give you a low-cost way to put the shares you want on layaway.

For more on the opportunity in stocks today, read about:

On Jan. 12, 2009, Fool co-founder David Gardner, Jeff Fischer, and their Motley Fool Pro team will accept new subscribers to their real-money portfolio service. Motley Fool Pro is investing $1 million of the Fool’s own money in long and short positions in a range of securities, including common stocks, put and call options, and exchange-traded funds (ETFs). They also incorporate proprietary CAPS "community intelligence" data into their research. To learn more about Motley Fool Pro and to receive a private invitation to join, simply enter your email address in the box below.

Fool contributor Dan Caplinger likes using options for non-leverage purposes. He doesn't own shares of the companies mentioned in this article. Intel is a Motley Fool Inside Value selection. Apple is a Stock Advisor pick. The Fool owns shares of Intel as well as covered calls on it. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy never asks you for a tip.


Read/Post Comments (1) | Recommend This Article (20)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 28, 2008, at 10:29 AM, wolfhounds wrote:

    This is a good strategy which I've used several times in the past, but the article doesn't mention the one caveat that is true with this option strategy. If the stock price falls by expiration, you can still lose a portion or all of your premium depending how far the stock has fallen from the strike price.

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 800861, ~/Articles/ArticleHandler.aspx, 12/22/2014 3:35:57 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement