Earn Income While You Wait for This Former Highflier to Recover
In a year’s time, traders saw Green Mountain Coffee Roasters (NASDAQ: GMCR) plummet from over $110 a share in September 2011 to finally stabilize at the $20 level, which the stock had not seen since the fall of 2009.
Currently, GMCR is trading above $24, with the $20 level being a pivot support area to lean on with extreme lows in the $17.75 area.
Because of the high volatility, another word for opportunity, the options on the stock offer many strategies with mathematical advantages over a straight purchase of the shares. One tactic in particular could allow us to collect income while we wait to get into the stock at an even bigger discount.
Cash-Secured Put Strategy
This strategy has the same mathematical risk profile as a covered call. With the put sale, there is an obligation to buy the stock at the strike price if it is assigned, allowing you to get into the stock at a discount. In fact, the true entry cost basis is even lower with the subtraction of the premium you earned when selling the put.
There are two rules that cash-secured put traders must follow to be successful.
Rule One: Only sell puts on stocks you want to own.
The intention of this strategy is to be assigned the stock as a long-term investment (each option contract represents 100 shares). So make sure you have the funds in your account to buy the stock at a discount if a sell-off continues. Paying in full ensures that no additional money is needed to hold the stock for potentially many months or even years until a price recovery.
Rule Two: Sell either of the front two option expiration months to take advantage of time decay.
Collect premium every month on put sales until you are assigned shares at a cost-reduced basis. Every month that you keep the premium is money subtracted from your entry price.
Recommended Trade Setup: Sell to open GMCR Nov 21 Puts at $1 or better.
This cash-secured put sale would assign long shares at $20 ($21 strike minus $1 premium), which is almost 20% lower than GMCR’s current price, and would cost you $2,000 per contract. Remember: Only sell this put if you want to own GMCR shares at a discount to the current price. If you are assigned the shares, a December covered call can be sold against the stock to lower your cost basis even further.
And if the stock does not fall below the strike price before expiration, you keep the premium you collected, essentially getting paid not to buy the stock.