Groupon (Nasdaq: GRPN) has been hit hard during the past year, but a price bottom may have formed with extreme lows below $3 a share. As of this writing, Groupon is trading around $5.36 a share. The unfilled gap down in August from $6.35 to the 52-week low at $2.60 has midpoint support at about $4.50 to lean on.
Due to volatility, another word for opportunity, the options on the stock offer many strategies with mathematical advantages over a straight purchase of the shares. If you are comfortable holding on to this inexpensive stock to wait for a potential recovery, then selling put options could allow you to collect income while you wait to get into the stock at a 16% discount.
Cash-Secured Put Selling Strategy
While the typical investor might use a limit order to buy a stock or exchange-traded fund (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.
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 occurs. 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.
Action to Take --> Sell to open GRPN March 5 Puts at 50 cents a share or better.
This cash-secured put sale would assign long shares at $4.50 ($5 strike minus $0.50 premium), which is about 16% below GRPN's current price, costing you $450 per option sold. Remember: Only sell this put if you want to own Groupon stock at a discount to the current price. If you are assigned the shares, an April 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.
This article originally appeared on ProfitableTrading.com:
Get Paid While You Wait for a Recovery in This $5 Stock