How To Buy Dow Holdings For A 9% Discount, Or Achieve A 17% Return

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Barchart – 1 hour ago

Selling cash secured puts on stocks an investor is happy to take ownership of is a great way to generate some extra income. 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. It’s important that anyone selling puts understands that they may be assigned 100 shares at the strike price.

Why Trade Cash Secured Puts?

Selling cash secured puts is a bullish trade but slightly less bullish than outright stock ownership. If the investor was strongly bullish, they would prefer to look at strategies like a long call, a bull call spread, or a poor man’s covered call. Investors would sell a put on a stock they think will stay flat, rise slightly, or at worst not drop too much. Cash secured put sellers set aside enough capital to purchase the shares and are happy to take ownership of the stock if called upon to do so by the put buyer.

Naked put sellers, on the other hand, have no intention of taking ownership of the stock and are purely looking to generate premium from option selling strategies. The more bullish the cash secure put investor is, the closer they should sell the put to the current stock price. This will generate the most amount of premium and also increase the chances of the put being assigned. Selling deep-out-of-the-money puts generates the smallest amount of premium and is less likely to see the put assigned.

DOW Cash Secure Put Example

Yesterday, with Dow Inc. (DOW) trading at $58.63, the February 2022 put option with a strike price of 55 was trading around $2.05. Traders selling this put would receive $205 in option premium. In return for receiving this premium, they have an obligation to buy 100 shares of DOW for $55. By February next year, if DOW is trading for $50, or $40, or even $10, the put seller still has to buy 100 shares at $55. But, If DOW is trading above $55, the put option expired worthless, and the trader keeps the $205 option premium.

The net capital at risk is equal to the strike price of 55, less the 2.05 in option premium. So, if assigned, the net cost basis will be 52.95. That’s not bad for a stock currently trading at $58.63. That’s a 9.69% discount from the price it was trading yesterday. If DOW stays above $55, the return on capital is:

$205 / $5,295 = 3.87% in 84 days, which works out to 16.82% annualized.

Either the put seller achieves an 16.82% annualize return, or gets to buy a high yielding, blue chip stock for a 9% discount. You can find other ideas like this using the Naked Put Screener. Below you can see some parameters that you might consider for running this screener. Feel free to tweak them as you see fit.

Dow Inc Outlook

While the returns on offer for selling puts and the dividend yield might be attractive, one concern is the technical outlook for DOW. The Barchart Technical Opinion rating is a 48% Sell with a Weakening short term outlook on maintaining the current direction.

Long term indicators fully support a continuation of the trend. Out of twelve analysts covering the stock, five have a strong buy rating, six have a hold rating and one has a moderate sell rating. Implied volatility for DOW is currently sitting at 27.19% which is an IV Percentile of 21%.

Summary

While this type of strategy requires a lot of capital, it is a great way to generate an income from stocks you want to own. If you end up being assigned, you can sit back and collect the fat 4.73% dividend on offer from DOW. You can do this on other stocks as well, but remember to start small until you understand a bit more about how this all works. If you have any questions, feel free to reach out to me by email or on Twitter.

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.

*Disclaimer: On the date of publication, Gavin McMaster did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. Data as of after-hours, Nov 25, 2021.