Collect Income While Waiting for This Former High-Flier to Recover
After plummeting from their atmospheric heights above $110, shares of Green Mountain Coffee Roasters (NASDAQ: GMCR) finally stabilized at the $20 level in 2012. The rally that followed stalled near the $44 level, which is the hallway retracement of the yearly high to the yearly low.
As of this writing, GMCR is trading above $39. The $30 level is the halfway support of the recent rally from the extreme lows.
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. In particular, selling put options could allow us to collect income while we wait to get into the stock at an even bigger discount.
Cash-Secured Put Selling 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 put selling, 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 from selling the puts.
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 traders must follow to be successful at selling put options.
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 GMCR Feb 31 Puts at $1 or better.
This cash-secured put sale would assign long shares at $30 ($31 strike minus $1 premium), which is about 24% lower than GMCR’s current price, and would cost you $3,000 per option sold. 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 March 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, then you keep the premium you collected, essentially getting paid not to buy the stock.
Note: My ProfitableTrading.com colleague, Amber Hestla-Barnhart, is putting the finishing touches on a report that answers 10 commonly asked questions about boosting income with options. If you’d like to learn more about generating income using options, simply click here and tell us where to send the report.