Gilead Sciences is showing high volatility due to the upcoming earnings announcement next Thursday.
High volatility means higher-than-normal option premiums, which can be great for option sellers.
In particular, put premiums are elevated. Traders selling puts on a stock are looking to take ownership of the stock at a price below the current market price.
A cash-secured put involves writing an at-the-money or out-of-the-money put option and simultaneously setting aside enough cash to buy the stock. The goal is to either have the put expire worthless and keep the premium, or to be assigned and acquire the stock below the current price.
Cash-covered puts are very similar to a covered call and are quite easy to understand once you know the basics.
Risk Of Having To Buy Gilead Stock
It's important that anyone selling puts understands that they may be assigned 100 shares at the strike price, if the stock is below the strike price at expiration.
Using Gilead stock as our example, a trader selling the May 19, 80-strike put could generate around $0.95 in premium per contract late Wednesday.
The put seller would have the obligation to purchase 100 shares of Gilead stock at 80 if called upon to do so by the put buyer.
The break-even price for the trade can be calculated by taking the strike price less the premium received. In this case, that's a break-even price of 79.05.
That's 6.02% below Wednesday's closing price.
If Put Expires Worthless, Trader Pockets The Premium
If the stock stays above 80 at expiry, the put expires worthless. It leaves the trader with a healthy 1.2% return on capital at risk. That works out to around 14% on an annualized basis.
The main risk with the trade is similar to outright stock ownership. If the stock falls precipitously, the trade will suffer a loss. However, the loss will be partially offset by the premium received for selling the put.
The maximum loss on the trade would occur if Gilead stock fell to zero, which would see the trade lose $7,905. But most traders would cut their losses long before then.
A stop loss could be set if Gilead stock drops below the 50-day moving average, currently around 82.
Strategy A Way To Generate Income
Cash secured puts are a fantastic way to generate a nice return on stocks the trader would be happy to own.
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.
According to the IBD Stock Checkup, Gilead stock is ranked No. 29 in its large industry group and has a Composite Rating of 85, an EPS Rating of 70 and a Relative Strength Rating of 90.
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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.
