Lowe's is set to report earnings on Tuesday before the market open; the options market is pricing in a 4.2% move in either direction. So let's look at selling a cash-secured put in LOW stock to take advantage of the high implied volatility around the earnings announcement.
A cash-secured put involves selling an at-the-money or out-of-the-money put option. The trade simultaneously sets aside enough cash to buy the stock.
The goal here? Either have the put expire worthless and keep the premium, or to take assignment and acquire the stock below the current price.
Cash-secured puts are very similar to a covered call and are quite easy to understand once you know the basics.
LOW Stock Today: The Cash-Secured Put
Traders who sell puts should fully understand that they may be assigned 100 shares per option contract at the strike price.
A trader selling the Aug. 25-expiring put option in LOW stock with a strike price of 217.50 will generate around $3.75 in premium per contract.
The put seller would have the obligation to purchase 100 shares of LOW stock at 217.50 if called upon to do so by the put buyer.
The break-even price for the trade? Calculate it by taking the strike price less the premium received. In this case, LOW stock gives a break-even price of 213.75. That's slightly more than 2.5% below Friday's closing price.
If LOW stock stays above 217.50 at expiry, the put option expires worthless. And it leaves the trader with a generous 1.75% return on capital at risk. That works out to around 128% on an annualized basis.
The Chief Risk
The main risk with the trade is similar to outright stock ownership. If LOW stock falls significantly, the trade will suffer a loss. However, the loss gets partially offset by the premium received for selling the put.
Cash-secured puts are a fantastic way to generate a return on stocks the trader is happy to own.
With this example, the trader either generates a 1.75% return in five days or gets to purchase LOW stock at a reasonable discount to Friday's price.
If Lowe's trades below 217.50 and the put gets assigned, investors can then sell covered calls against the position to generate further income.
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.
