By Owen Trimball
Bottom fishing stocks is a saying used to describe a stock buying technique which focuses on shares in a company whose stock has taken a significant and decisive price dive along with notably higher volume of shares traded.
The overall idea is that the explosive volume is likely to wash the sellers out of the market, leaving it ready for the buyers to come back in and take the share price to higher levels. Hence the expression “bottom fishing stocks” – you’re fishing for stocks at what you believe could be the bottom levels of it’s price action and well positioned for a turnaround.
Buying These Stocks at a Discount
Once you understand option trading you’ll realize that it is possible to both buy (go long) or sell (go short) option contracts. You’ll also know that in the usa one option contract covers 100 shares while in other countries such as Australia, they give you control over 1,000 shares – so you’ll need to take this into account when deciding on the amount of capital you wish to invest. Do you plan to purchase multiples of 100 or 1000 shares?
The best way to illustrate bottom fishing stocks for a discount using options is to take an imaginary example. Let’s say XYZ company stocks have recently dropped significantly to around $17 on high volume – sometimes labeled as ‘capitulation volume’. The stock has since been trading within a range and you believe it can’t fall much further so it will still be value for money if it goes as far as the $15 price level. You also possess enough capital to acquire 500 shares.
Here’s what you can do:
You sell 5 put option contracts for a strike price of $15 for expiry the following month and in addition buy an additional 5 put option contracts at a lower strike price, same expiry date. This is called a put credit spread, otherwise known as a “bull put spread”. You need the bought position as a form of insurance protection in the event the stock plummets even further. You will be given a net credit into your brokerage account. Once this is done, three eventualities can follow:
1. The stock stays around the $17 level by option expiry date. In this case you can keep the credit you’ve received and may decide to sell another put credit spread for the following month. You have effectively been paid for waiting for the stock to arrive at your desired level.
2. The stock falls to $15 and you are exercised on your sold options and the stock is put to you. You now own 500 shares of XYZ and can then employ further strategies using options, for example selling covered calls with protected puts.
3. The stock continues its decline to way below $15. In cases like this, the stock will be assigned to you, however your bought puts will improve in value and limit your potential losses. You could utilize the profit from these bought puts to purchase more shares and in the process, 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 the best time to make use of this strategy, is the fact that along with the huge stock selloff, the implied volatility in put option prices will normally be elevated. Consequently the near-money options you sell will probably 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.
About the Author
Owen has traded options for many years and is writes for “Options Trading Mastery” – a popular site which explores the best option trading systems. Discover some great Option Trading Strategies here and empower yourself for trading success!
