In a landscape of broken charts and volatility, the energy sector is standing out for its relative strength. It's one of the few areas where names like HAL stock are making new highs. But if you want to buy it at a discount, here's an option strategy that can do it.
Cash-Secured Put Strategy
Looking at the chart of Halliburton, you wouldn't know that we had a market in correction until yesterday. The sector is one of the standouts to start the year, with double digit gains in January. HAL stock is currently showing a perfect Composite Rating of 99, an EPS Rating of 72 and a Relative Strength Rating of 98.
But if you are concerned with it being extended, consider a cash-secured put. It can let you take ownership of HAL stock for less than the current 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. If HAL stock trades much higher, the put will expire worthless and you keep the premium. If it sees a pullback below the strike, you may be assigned the stock. But, you will acquire your HAL stock at a discount. A cash-secured put is considered a neutral to slightly bullish trade.
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.
But traders selling puts should be ready to own 100 shares per contract of the underlying stock at the strike price.
Option Strategy With HAL Stock
Let's look at an example using Halliburton stock.
With the stock trading at 30.69 yesterday, investors could sell an April put with a strike price of 30 for around $2.10.
An investor selling this put receives $210 into their account. If HAL stock trades above 30 on April 14, that entire premium is theirs to keep.
But what if it undergoes a normal pullback? If HAL stock falls below 30 by April 14, the investor should expect assignment. That means be ready to buy 100 shares at 30. What helps is that you still have the option premium received to offset the cost. The effective net cost of the position would be 27.90, thanks to the $2.10 in option premium. That's 9% below yesterday's closing price on HAL stock.
The main risk with the trade is similar to stock ownership. If the stock falls quickly, the trade will suffer a loss. However, the premium received helps offset the loss as opposed to just buying HAL stock outright.
Like owning any stock, your maximum loss on the trade occurs if HAL stock falls to $0. The trade loses $2,790 in that unlikely and extreme case, but most traders would cut losses long before then.
If the stock stays above 30 at expiry, the put expires worthless and the premium is yours to keep. That gives the trader a 7.5% return on capital at risk, which is 38% annualized.
The Trade Doesn't Have To End There
Cash-secured puts are a great way to generate a return on strong stocks, potentially without ever having to take ownership. If you take ownership of HAL stock, you may participate in a strong move with a reduced cost base. That might see a much larger return than the option premium received.
You could also turn an acquired HAL stock position into an income producer. By selling covered calls on the stock, you could 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
