Earn Income While Waiting for a Comeback in This Battered Retailer

J.C. Penney Company (NYSE: JCP) shares lost more than half of their value in 2012. The sell-off came after posting multi-year highs above $43 in February, even against a backdrop of a tough economy. 

A $20 support base has been violated with the latest price push to the downside. As of this writing, JCP is trading around $19.70. The $20 level is a pivot support area to watch on a weekly basis with extreme lows from 2009 in the $14 area. Before recently, JCP had not been below $20 since 2009.

JCP Chart

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.

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Cash-Secured Put Strategy

While the typical investor might use a 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 by 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 the options strike price 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 JCP Jan 17.50 Puts at $0.75 or better.

This cash-secured put sale would assign long shares at $16.75 ($17.50 strike minus $0.75 premium), which is about 15% lower than JCP’s current price, costing you $1,675 per option sold. Remember: Only sell this put if you want to own JCP shares at a discount to the current price. If you are assigned the shares, a February covered call can be sold against the stock to lower your cost basis even further.

If the stock does not fall below the strike price before expiration, then you keep the premium you collected, essentially getting paid not to buy the stock.