Traders Could Get a Second Chance to Pocket Income From This $5 Stock

StreetAuthority Network

The last month has seen big changes at Internet deal maker Groupon (GRPN). CEO Andrew Mason was ousted after the company reported another big earnings miss, which created a high level of fear among investors. That fear, i.e., volatility has decreased from close to 100%, but it remains at a lofty 60% as management tries to sort out the future of the company.

Shares have been hit hard during the past year, but a price bottom may have formed with the extreme lows below $3 per share. As of this writing, GRPN is trading around $5.10 a share. The unfilled gap down in August from $6.35 to the 52-week low at $2.60 has midpoint support at about $4.50 to lean on.

View photo

.
Groupon Stock Chart

In February, I recommended traders consider selling the GRPN March 5 Puts at $0.50 or better. Those options are set to expire Friday, and unless Groupon closes the day below $5, sellers will keep their full premium as profit. (If shares do fall below $5, sellers will be "put" the stock at a 16% discount from the time we sold the option.)

If those options do expire worthless, I think selling another put this month will be an attractive strategy due to the high volatility, which drives up options premiums. Traders will continue collecting income while they wait for a chance to get into the stock at an 8% discount from current prices.

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 GRPN April 5 Puts at $0.30 or better.

This cash-secured put sale would assign long shares at $4.70 ($5 strike minus $0.30 premium), which is about 8% below GRPN's current price, costing you $470 per option sold. Remember: Only sell this put if you want to own GRPN 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.

Related Articles

View Comments