Big trader finds brilliant way to bet on GM
It might be the most famous market axiom: Buy low and sell high. But for savvy options traders, an even better idea may be to sell put options. And that's just what one big trader did on a hard day for General Motors.
GM shares fell more than 3 percent Monday as news of deep discounts on trucks taxed the stock, leading automakers to be the S&P 500's worst-performing industry on the day. But one major options trader looked to take advantage of that downdraft by selling 4,700 January 2015 30-strike GM puts for about $2 each.
(Read more: GM falls as media reports on President's Day sale)
This trade grants the seller nearly $1 million in premium, in exchange for obligating him to buy the stock for $30 in January 2015 if it falls beyond that level. However, subtracting the $2, the stock will be bought at an effective price of $28 a share—a 20 percent discount from where GM closed Monday.
Even better, while buying the stock would tie up capital, the trader now has the opportunity to reinvest that $1 million.
"If you look at the charts, it looks pretty ugly, so amateurs would stay away—but professionals realize if you're going to buy the stock, then the time to buy it is when it's at a discount," said Scott Nations of NationsShares. "And if you're a real professional, you realize a great way to do that is to sell a put, because puts are so much more expensive now that the stock has rolled over."
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In the worst-case scenario, GM shares fall to $0, and the trader will be on the hook for $28. But few would consider that a particularly likely outcome.
So for those who believe in the long-term picture for the stock and therefore aren't afraid of taking on some downside risk, a put sale might be a good option to consider.