BHP is looking strong and was recently added to the IBD 50.
One way to take ownership of a stock for less than the price it is currently trading is via an option strategy called a cash secured put.
A cash secured put is a slightly less bullish trade than buying the stock. It is considered a neutral to slightly bullish trade.
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.
Selling Puts Is An Easy Strategy
Selling put options is an easy place for investors to start out with options. They are very similar to a covered call and are quite easy to understand once you know the basics.
It's important that anyone selling puts understands that they may be assigned — i.e., forced to buy — 100 shares at the strike price.
Let's take a look at an example using the stock of Australian mining company BHP, formerly known as BHP Billiton.
With the stock trading at 67.59 Wednesday, investors could sell a July 15 put with a strike price of 65 for around $2.05.
An investor selling this put would receive $205 into their account, which would be theirs to keep. If BHP falls below 65 by July 15, the investor would be required to buy 100 shares at 65. The effective net cost of the position would be 62.95 thanks to the option premium received.
That's 6.86% below Wednesday's closing price.
Put Expires Worthless Above 65
If BHP stock stays above 65 at expiry, the put expires worthless. That leaves the trader with a healthy 3.26% return on capital at risk.
The main risk with the trade is similar to outright stock ownership. That is, if the stock falls quickly, 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 BHP fell to $0, which would see the trade lose $6,295. But most traders would cut losses long before then.
Cash secured puts are a wonderful way to generate a healthy 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 further income from the position.
BHP Stock No. 1 In Its Industry
According to the IBD Stock Checkup, BHP is ranked No. 1 in its industry group and has a Composite Rating of 98, an EPS Rating of 97 and a Relative Strength Rating of 93. The stock is forming a cup base and is holding above the 50-day moving average.
It's important to 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
