Earnings season is back and Wells Fargo is set to report on Friday before the opening bell. The options market is pricing in a 4.3% move in either direction. Today, we're looking at selling a cash secured put on Wells Fargo stock to take advantage of the high implied volatility around the earnings announcement.
Cash-Secured Put On Wells Fargo Stock
A cash-secured put involves selling an at-the-money or out-of-the-money put option. You simultaneously set aside enough cash to buy the stock.
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.
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 100 shares at the strike price.
For Wells Fargo, the options market shows an implied volatility of 28.8% compared to a 12-month low of 17.5% and a high of 41.5%.
The implied volatility percentage is 73% and the implied volatility rank is 47%. When implied volatility is high, that's a time where selling premium is advantageous.
Setting Up The Trade
For Wells Fargo, a trader selling the April 19 put with a strike price of 55 will generate around 74 cents in premium per contract.
The put seller would have the obligation to purchase 100 shares of WFC stock at 55 if called upon to do so by the put buyer.
The break-even price for the trade can be calculated by taking the strike price less the premium received. In this case, that gives a break-even of 54.26.
That's 5.8% below yesterday's closing price.
If the stock stays above 55 at expiry, the put option expires worthless. It leaves the trader with a healthy 1.3% return on capital at risk in just over a week's time. That's not a bad annualized return.
Trade Risks
The main risk with the trade is similar to outright stock ownership. If the stock falls significantly, the trade will suffer a loss. However the loss is 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 1.3% return in nine days, or they get to purchase Wells Fargo at a reasonable discount to yesterday's price.
If WFC stock trades below 55 and the put gets assigned, investors can then sell covered calls against the position to generate further income.
According to the IBD Stock Checkup, Wells Fargo stock is ranked No. 8 in its industry group. It has a Composite Rating of 85, an EPS Rating of 56 and a Relative Strength Rating of 89.
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 X/Twitter at @OptiontradinIQ
