Using Options to Bottom Fish for Stocks

Bottom fishing stocks is a term used to explain a share purchasing technique which specializes in shares from a company whose stock has taken a significant and decisive price dive combined with notably increased volume of shares traded.

The overall theory is that the explosive volume has a tendency to wash the sellers out of the market, providing opportunity for the buyers to return and bid up the share price to higher levels. Hence the term "bottom fishing stocks" - you're fishing for stocks at what you believe will likely be the bottom levels of it's price action and ready for a turnaround.

Buying These Stocks at a Discount

Once you understand option trading you'll recognize that you are able to both buy (go long) or sell (go short) option contracts. You'll also realize that in the usa one option contract covers 100 shares while in other countries for example Australia, they give you control over 1,000 shares - so you should bear this in mind in connection with how much capital you wish to invest. Do you plan to purchase multiples of 100 or 1000 shares?

The simplest way to illustrate bottom fishing stocks for a discount using options is to take an imaginary example. Suppose XYZ company stocks have recently dropped dramatically to around $17 on large trading volume - sometimes labeled as 'capitulation volume'. The stock has since been trading within a price range and your assessment is that it can't fall much further so it will still be a good buy if it goes as far as the $15 price level. You also possess sufficient capital to purchase 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 also purchase another 5 put option contracts at a lower exercise price, same expiry date. This is called a put credit spread, also known as a "bull put spread". You will need the bought position as a kind of insurance protection should the stock plummet further. You will receive a net credit into your brokerage account. Once this is accomplished, three eventualities can follow:

1. The stock remains around the $17 level by option expiry date. In this instance you're able to keep the credit you have received and can decide to write 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 instance selling covered calls with protected puts.

3. The stock plummets to way below $15. In cases like this, the stock will be assigned to you, but your bought puts will improve in value and limit your potential losses. You could utilize the profit from these bought puts to invest in 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 normally be elevated. This means that the near-money options you sell will probably be at inflated prices, thus furnishing you with an even greater credit for the transaction. You get paid a handsome sum for simply waiting for the stock to fall further - if it does.