Buy RIMM at a 20% Discount… or Get Paid Not To

Last month, a combination of high volatility and drastic long-term price decline made BlackBerry maker Research In Motion (NASDAQ: RIMM) a great candidate for a cash-secured put strategy. Specifically, I recommended selling to open the RIMM Aug 7 Puts at 50 cents or better.

With RIMM trading at $7.30 at that time, the idea was that if the stock fell below the strike price, traders would be assigned long shares at a 10% discount at $6.50 ($7 strike minus 50-cent premium), which was below RIMM’s 52-week low. And if shares did not drop below $7, traders could pocket the premium from the put sale and move on to the next opportunity, essentially getting paid not to own the stock.

With RIMM currently above $8 and options expiration this Friday, it looks like these puts will expire worthless and we will keep the premium. And a new high-probability trade is setting up for the September option series.

Cash-Secured Put Strategy

While the typical investor may use a straightforward limit order to buy a stock 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.

Research In Motion Replay

As of this writing, RIMM is trading around $8.10. At some point, it is likely that Research In Motion’s intellectual property and the value of the company’s patents will be attractive and the stock will rebound. The one thing we know for sure is that the downside is limited to zero, but a partnership or takeover is a more likely scenario.

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 RIMM Sept 7 Puts at 50 cents or better. 

This cash-secured put sale would assign long shares at $6.50 ($7 strike minus 50-cent premium), which is about 20% lower than RIMM’s current price, and would cost you $650 per contract. Remember: Only sell this put if you want to own RIMM shares at a discount to the current price.

And if you do end up owning RIMM, you may want to consider selling an October covered call against the stock to lower your cost basis even further.