Profitable Income Strategy Presenting Traders With Another Lucrative Setup
Over the past few months I have recommended using a cash-secured put selling strategy with Facebook (NASDAQ: FB). As the options sold expired worthless, we were essentially getting paid not to own the stock. When the stock was put to us at a discounted price, following my recommendation to sell a covered call allowed traders to exit with a tidy profit.
Now, it appears a similar trade setup could once again be presenting itself.
FB looks to have formed a bottom and the high relative volatility makes the put selling strategy attractive to enter the shares at a lower price. Support sits at $24 from the September, October and November lows to the December highs and should hold on sell-off dips.
Cash-Secured Put Strategy
While the typical investor may use a straightforward limit order to buy a stock or ETF at a designated price or lower, the options trader can do one better by selling a cash-secured put.
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.
And if the stock is not below the strike price at expiration, then the premium received is all profit. In other words, you’re getting paid not to own the stock.
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 FB Jan 23 Puts at $0.50 or better.
This cash-secured put sale would assign long shares at $22.50 ($23 strike minus $0.50 premium), which is about 13% lower than FB’s current price, costing you $2,250 per contract purchased. Remember: Only sell this put if you want to own FB shares at a discount to the current price. And if the stock does not fall below the strike price, you keep the premium you collected, essentially getting paid not to buy in at a discount. With January options expiration in three short weeks, time decay is working in put sellers’ favor.
If the stock is assigned, a February covered call can be sold against the stock to lower the cost basis again.