The ‘Backdoor’ Way to Profit From This Beaten-Down Commodity
The recent bounce in volatility, a cost component in an option‘s price, has made premium-selling strategies more attractive. After a new five-year low in the CBOE Volatility Index (VIX) on Aug. 17, this measure has jumped around 30%.
Simply put, traders want to buy premium when volatility is low and sell premium when it is high to take advantage of strategy and probability. In today’s trade, I will focus on a put selling strategy to allow traders to collect a premium and potentially get into a commodity ETF at a discount.
United States Natural Gas (NYSE: UNG) is currently trading at about $18.80 per share. After making a multi-year low at $14.25 this spring, the ETF is now above the $18 halfway support point between the April low and August high at $22.
This seems like a cheap price to enter UNG, but options traders can get an even bigger discount on the ETF while waiting for it to recover.
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.
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 UNG Sept 17 Puts at 50 cents or better.
This cash-secured put sale would assign long shares at $16.50 ($17 strike minus 50-cent premium), which is about 12% lower than UNG’s current price, and would cost you $1,650 per contract. Remember: Only sell this put if you want to own UNG shares at a discount to the current price.
If you do end up owning UNG, you may want to consider selling an October covered call against the stock to lower your cost basis even further.