UnitedHealth Group is set to report earnings on Friday before the market open. Last week, we laid out an iron condor on UNH stock betting on a rangebound reaction. If you are a little more bullish, this cash-secured put is another way to go.
Cash-Secured Put Basics
Selling options is often preferred when implied volatility is high. Since stocks can make big moves on earnings announcements, implied volatility tends to spike just before the announcement.
With earnings coming on Friday for UNH stock, this makes it a candidate for taking advantage of the higher implied volatility.
A cash-secured put involves selling an at-the-money or out-of-the-money put option. Simultaneously, you set aside enough cash to buy the stock if assigned.
The goal is to 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 covered calls and are quite easy to understand once you know the basics.
It's important that anyone selling puts understands that they may be assigned 100 shares at the strike price.
UNH Stock Option Trade Setup
For UNH stock, a trader selling the Oct. 13 put with a strike price of 510 will generate around 2.70 in premium per contract.
As the put seller, you have the obligation to purchase 100 shares of UnitedHealth Group stock at 510 if called upon to do so by the put buyer.
To calculate the break-even price for the trade, take the strike price less the premium received. In this case, that gives a break-even price of 507.30.
That's 3.5% below the current price around 525.60.
If UNH stock stays above 510 at expiry, the put option expires worthless. That leaves the trader with a generous 0.5% return on capital at risk. It might not seem like much but that's in less than a week's time. Annualize that number and it works out to be 47%.
Managing The Trade
The main risk with the trade is similar to outright stock ownership. If UNH stock falls significantly, the trade will suffer a loss. However, the loss will be 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 0.5% return in 4 days, or they get to purchase UNH stock at a reasonable discount to the current price.
If UnitedHealth Group stock trades below 510 and the put gets assigned, investors can then sell covered calls against the position to generate further income.
According to the IBD Stock Checkup, UNH stock is ranked No. 1 in its industry group and has a Composite Rating of 95, an EPS Rating of 92 and a Relative Strength Rating of 83.
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
