Despite rising interest rate fears, the strength in the building sector has been undeniable. Builders FirstSource is one of those strong movers. BLDR stock is above rising 21-, 50- and 200-day moving averages. A cash-secured put gives us the ability to either get income or potentially pick up shares at a discount.
According to the IBD Stock Checkup, BLDR stock is ranked No. 9 in its industry group, and has a Composite Rating of 94, an EPS Rating of 88 and a Relative Strength Rating of 98.
Cash-Secured Puts Have Two Ways To Win
Selling put options is an easy place for investors to start with options. They are like a covered call and are pretty easy to understand once you know the basics.
A cash-secured put is a slightly less bullish trade than buying the stock outright. It is considered a neutral to slightly bullish trade.
With a cash-secured put, you write (meaning sell) an at-the-money or out-of-the-money put option and simultaneously set aside enough cash to buy the stock. Traders selling puts should understand that they may be assigned 100 shares at the strike price.
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There are two ways to win here. Using BLDR stock as an example, if it stays above the chosen strike price of the sold put by expiration, the put expires worthless and you keep the premium. BLDR stock doesn't even need to go up. Sideways movement still gets you the objective here.
What if BLDR stock falls? Then expect to be assigned the stock (that's why you set aside the cash just in case). But, not only do you acquire the stock below the current price but also with a lower cost basis because of the premium collected.
Let's look at the details of a trade using BLDR stock.
Setting Up The Trade With BLDR Stock
With BLDR stock trading around 116 this morning, investors could sell an August put with a strike price of 110 for around $5.70.
An investor selling this put receives $570 into their account, which is theirs to keep. But it's not free money. If BLDR stock falls below 110 by Aug. 18, you are taking on the obligation of buying 100 shares at 110.
Let's look at our two scenarios.
If the stock falls below the 110 strike before expiry, prepare to be assigned. But your cost on BLDR stock would be 104.30 as opposed to 116. That's a 10% discount to the current price and also your maximum risk.
In that way your risk is similar to that of outright stock ownership. In the unlikely event that BLDR stock falls to $0, the trade would lose $10,430. But that is still less than buying the stock outright since the premium helps offset some losses. And of course most traders would cut losses long before then.
What if BLDR stock rises or goes sideways? If the stock stays above 110 at expiry, the put expires worthless, leaving the trader with a 5.5% return on capital at risk (5.70 premium/104.30 maximum risk).
That works out to be 25% annualized.
Cash-secured puts are a great way to generate a return on strong stocks, potentially without ever having to take ownership.
If the put does get assigned, the investor takes ownership with a reduced cost base and can potentially begin selling covered calls to generate additional income from the position.
Please remember that options are risky, and investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ
