RadioShack's (NYSE: RSH) brand may be recognizable, but the same cannot be said for its stock. Shares of the once-popular electronics retailer fell from $24 in 2010 to 20-year lows below $2 currently.
On the one-year chart, the August low was eclipsed by the January low, but volatility did not make new highs. A bullish divergence like this is often a sign of price stability, and RSH rebounded 38% into its March high.
The bounce in February and March gave way to selling pressure and new lows below $2. But again, we did not see new highs in volatility.
Technically, RSH has traded in a channel from $4 to $2 since mid-2012. An upside breakout targets a move to $6 once a price base has finally been made. Traders should watch the $2 level on a weekly basis for support.
If you are comfortable holding on to this inexpensive stock for a potential recovery, then selling puts could allow you to collect income while you wait to get into RSH at a 12% 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 option.
This strategy has the same mathematical risk profile as a covered call. When selling puts, there is an obligation to buy the stock at the option's 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 puts.
Rule 1: Sell put options only on stocks you want to own.
The intention of the put selling 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 option's 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 2: Sell either of the front two option expiration months to take advantage of time decay.
Collect premiums each month from selling puts 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 RSH May 2 Puts at $0.25 or better. (Use a limit order to get the desired level of income.)
This cash-secured put sale would assign long shares at $1.75 ($2 strike minus $1.75 premium), which is about 12% below RSH's current price, costing you $175 per option sold. If the put option expires worthless, you keep the $25 premium, earning a potential 14.3% return in 32 days.
Remember, you should sell this put option only if you want to own RSH at a discount to the current price. If you are assigned the shares, a June covered call can be sold against the stock to lower your cost basis even further. If RSH 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 was originally published at ProfitableTrading.com:
Under $2 Stock Could Pay a 14% 'Dividend' in Just Over a Month