Out-of-Favor Stock Offers Instant Payday Ahead of a Potential Turnaround

StreetAuthority Network

While equities have risen to multi-year highs, many commodities and natural resources companies have largely been left in the dust. But the best time to buy something is often when it is out of favor and not in demand... yet.

One stock in this sector that has seen a sharp decline during the past two years is Cliffs Natural Resources (CLF), a major producer of iron ore pellets and metallurgical coal. The stock has suffered a crushing blow, falling from over $100 per share in 2011 to the $20 level.

As of this writing, CLF stock is trading at about $20.70, slightly above its 52-week low of $20.06. The $20 level is the long-term pivot support on a monthly closing basis dating back to 2009.

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CLF Stock Chart

If you are comfortable holding on to this stock at a deep discount to wait for a potential recovery, then selling put options could allow you to collect income while you wait to get into the stock at a 15% discount.

Cash-Secured Put Selling Strategy

While the typical investor might use a limit order to buy a stock or ETF at a designated price or lower, the options trader can do one better by selling a cash-secured put.

This strategy has the same mathematical risk profile as a covered call. With put selling, there is an obligation to buy the stock at the strike price if it is assigned, allowing you to get into the stock at a discount. In fact, the true entry cost basis is even lower with the subtraction of the premium you earned from selling the puts.

And if the stock is not below the strike price at expiration, then the premium received is all profit. In other words, you're getting paid not to own the stock.

There are two rules traders must follow to be successful at selling put options.

Rule One: Only sell puts on stocks you want to own.

The intention of this strategy is to be assigned the stock as a long-term investment (each option contract represents 100 shares). So make sure you have the funds in your account to buy the stock at the options strike price if a sell-off occurs. Paying in full ensures that no additional money is needed to hold the stock for potentially many months or even years until a price recovery.

Rule Two: Sell either of the front two option expiration months to take advantage of time decay.

Collect premium every month on put sales until you are assigned shares at a cost-reduced basis. Every month that you keep the premium is money subtracted from your entry price.

Recommended Trade Setup: Sell to open CLF April 18 Puts at $0.50 or better.

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CLF Stock Options

This cash-secured put sale would assign long shares at $17.50 ($18 strike minus $0.50 premium), which is about 16% below CLF's current price and below its 52-week low, costing you $1,750 per option sold. Remember: Only sell this put if you want to own CLF stock at a discount to the current price. If you are assigned the shares, a May covered call can be sold against the stock to lower your cost basis even further.

If the stock does not fall below the strike price before expiration, then you keep the premium you collected, essentially getting paid not to buy the stock.

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