Earn Income While Waiting for This Beaten-Down Stock to Bounce Back

Friday, November 16, 2012 - 5:00am

by Alan Knuckman

Green Mountain Coffee Roasters' (Nasdaq: GMCR) shares have dropped from atmospheric heights over $100 in 2011 to finally stabilize at the $20 level, which the stock has not seen since 2009.   

As of this writing, Green Mountain is trading around $24. The $20 level is a pivot support area to lean on with extreme lows at the $17 area.

 

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.

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 thestrike 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.

Action to Take --> Sell to open Green Mountain Dec 20 Puts at $1 or better.

 

This cash-secured put sale would assign long shares at $19 ($20 strike minus $1 premium), which is 22% lower than Green Mountain's current price, and would cost you $2,000 per contract. Remember: Only sell this put if you want to own Green Mountain shares at a discount to the current price. If you are assigned the shares, a January 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, you keep the premium you collected, essentially getting paid not to buy the stock.

Alan Knuckman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.