A Beautiful Gold Trade – Part 2

Here’s how the Newmont (NEM) Gold trade is working out.

You’ll recall that I sold a gold stock for 125% gain because it wasn’t paying a dividend.  And I looked for another gold stock that was paying a dividend, and finally chose Newmont Mining Corp because it was a well established company and paid over a 3% dividend – see A Beautiful Gold Trade.

Now, I could have just bought the stock outright for $43.34 a share.  And I don’t think that would have been a bad decision.  The stock price was low enough.  And had I done that, I would already be up over 2% in just eight days.

But instead, I chose to do something different.

I chose to see if I could buy it cheaper – at $42 a share.  But I didn’t just put a $42 order out there.  Instead, I got someone to pay me $112 to buy it  at the cheaper price if it went down.  And they paid me immediately.  The money went straight into my trading account.

Nice.  Very nice indeed.  After all, I already know I want to buy the stock.  And now someone is paying me for the privilege to buy it at a cheaper price.  It’s good work if you can get it.

So how did I do that.  It’s simple, really.

I just sold a March $42 put option on Newmont for $112.

So what does that mean?  All it really means is I entered into a contract with someone whereby I promised that if Newmont went down to $42 a share or below, I would buy 100 shares of their stock for $42.

And after March, if the stock hadn’t gone down to $42 or below, our deal was off and I kept their $112.

We all enter into financial contracts / obligations at one time or another.  So don’t let the contract word scare you off.  If you have ever signed a mortgage, or bought an automobile on credit, you have enter into a contractual financial obligation.

So we know why I would would to do this.  I get $112 up front, and the possible opportunity to buy a stock I would like to own for a cheaper price.

But why would they want to pay me $112 to do this?  Well, maybe they were worried about the price and wanted assurance they can get out if the price starts going down.  So in a sense, I am providing them some price insurance for a couple of months.

And we all know that insurance costs a premium – which is what the $112 they paid me is.  In fact, in stock options talk, it’s actually called a premium.

So that’s the first part of the trade.  But it gets better, and I’ll tell you about that in the next post.

In the meantime, don’t rush out and sell puts on this stock.  You need to see the whole trade.  And I’ll leave you with two cautionary notes.

The first is that I must have $4200 available to do this trade.  After all, I just took on a contractual obligation to buy 100 shares of stock for $42 if the price dropped that low and they chose to exercise their option.  And the second  cautionary note is gold stocks are very volatile – so this could happen any time in the next two months.

So keep your powder dry on this trade until you see the entire picture.

To your health and prosperity – John

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