Steel Dynamics looks like it's trying to stage a comeback after its latest correction. It's trading back above its 50- and 200-day moving averages and is back on the IBD 50. The cash-secured put is a way to use options to potentially buy STLD stock at a discount.
Multiple Ways To Win On A Trade
A cash-secured put is a slightly less bullish trade than buying STLD stock outright.
In order to execute the trade, you write (sell) an at-the-money or out-of-the-money put option and simultaneously set aside enough cash to buy the stock. There's multiple ways to win on the trade.
If the put expires worthless, it's like an income trade. You keep the premium as a profit.
If the STLD stock falls below your strike at expiration, expect to acquire the stock. But you'll pick it up at a discount to the current price.
Selling put options is an easy place for investors to start out with options. They are very similar to covered calls (an example of a covered call is shown in the video above).
It's important that anyone selling puts is prepared to be assigned 100 shares at the strike price. So you set aside the money for that purchase in case it happens.
Let's flesh out the details with STLD stock.
Cash-Secured Put On STLD Stock
With STLD stock trading at 77.38 yesterday, investors could sell a Sept. 16 put with a strike price of 75 for around $3.60.
An investor selling this put receives $360 into their account which is theirs to keep. But you will also set aside $7,500 to buy STLD stock in case of assignment.
If Steel Dynamics stock falls below 75 by Sept. 16, expect to fulfill your obligation to buy 100 shares at 75. But, the effective net cost of the position is 71.40 thanks to the option premium.
That's 7.7% below yesterday's closing price for STLD stock.
If the stock stays above 75 at expiry, the put expires worthless leaving the trader with a healthy 5% return on capital at risk in 45 days. That works out to around 41% per annum.
Risks And Rewards
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 is partially offset by the premium received for selling the put.
The maximum loss on the trade occurs in the unlikely case that STLD stock falls to $0. In that case, the trade loses $7,140. Again, your discounted price means less capital is at risk. In reality, 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.
According to the IBD Stock Checkup, STLD stock ranks No. 1 in its group and has a Composite Rating of 98, an EPS Rating of 98 and a Relative Strength Rating of 93.
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
