Bottom fishing stocks is usually a saying used to explain a stock purchasing plan which targets shares from a company whose stock has experienced a considerable and decisive price dive associated with notably higher volume.
The overall theory 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 expression "bottom fishing stocks" – you’re trawling for stocks at what you consider will likely be the bottom levels of it’s price action and that are ready for a turnaround.
Buying These Stocks at a Discount
Once you understand option trading you’ll recognize that it is possible to both buy (go long) or sell (go short) option contracts. You’ll also realize that in the united states one option contract covers 100 shares while in other places for example Australia, they cover 1,000 shares – so it is important to bear this in mind when it comes to the level of capital you intend to invest. Do you intend to purchase multiples of 100 or 1000 shares?
The best way to illustrate bottom fishing stocks for a discount using options would be to take an imaginary example. Suppose XYZ company stocks have recently dropped dramatically 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’s a good buy if it goes as far as the $15 price level. You also possess enough capital to purchase 500 shares.
This is what you can do:
You sell 5 put option contracts for a strike price of $15 for expiry the following month and also purchase another 5 put option contracts for a lower strike price, same expiry date. This is called a put credit spread, also known as a "bull put spread". You need the bought position as a type of insurance protection in the event the stock plummets further. You will be given a net credit to your brokerage account. Once this is done, three eventualities can follow:
-
The stock stays around the $17 level by option expiry date. In this case you get to keep the credit you’ve been given and can elect to write another put credit spread for the following month. You have effectively been compensated for waiting for the stock to reach your desired level.
-
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.
-
The stock continues its decline to way below $15. In this case, the stock will be assigned to you, however your bought puts will improve in value and limit your potential losses. You could utilize the gain from these bought puts to acquire more shares and in doing this, average down your entry price as part of a longer term wealth building plan.
Bottom Fishing Stocks Using Inflated Option Prices
One of the reasons bottom fishing stocks is a better time to make use of this strategy, is that due to the huge stock selloff, the implied volatility in put option prices will usually be high. Consequently the near-money options you sell will be at inflated prices, thus bringing you an even greater credit for the transaction. You get paid a handsome sum for simply waiting for the stock to fall further – whether or not it does.