Amazon.com found support at its rising 50-day moving average line after a brief pullback. With earnings next week, put sellers can benefit from elevated option premiums. A cash-secured put on AMZN stock brings in premium if the stock goes up and gets you the stock at a discount if it goes down.
Cash-Secured Put Strategy
A cash-secured put is a slightly less bullish trade than buying the stock. It is considered a neutral to slightly bullish trade.
A cash-secured put involves writing (selling) 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 be assigned and acquire the stock below the current price.
Selling put options is an easy place for investors to start with options. They are like a covered call and are pretty easy to understand once you know the basics. With AMZN stock, there is plenty of liquidity in the options market that makes things even easier.
According to IBD Stock Checkup, AMZN stock is ranked No. 9 in its group and has a Composite Rating of 59, an EPS Rating of 41 and a Relative Strength Rating of 83. Not necessarily the most robust expectations for growth but it's Amazon, so it's probably not going bust anytime soon.
Traders selling puts need to understand that they may be assigned 100 shares at the strike price.
Using AMZN Stock For The Trade
Let's look at an example using AMZN stock.
With the stock trading just under 130, investors could sell an Aug. 18 put with a strike price of 122 for around 2.15.
An investor selling this put receives $215 into their account. If AMZN stock goes up from here or a least gets continued support at its 50-day line, the full premium gets kept. As long as the stock stays above 122 at expiry, the put expires worthless.
That leaves the trader with a 1.8% return on capital at risk, which works out to be 29% annualized.
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But what if AMZN stock falls below 122 by Aug. 18? Then the put seller has the obligation to buy 100 shares at 122. The effective net cost of the position is 119.85, thanks to the option premium received. That's why the cash is there for the purchase in that scenario.
Consider that it means you pick up AMZN stock 7% below the current price and a good distance below the 50-day line currently at 125.
Managing The Trade
The main risk with the trade is similar to outright stock ownership. If AMZN stock falls quickly, the trade will suffer a loss. However, the premium received helps offset the loss.
The maximum loss on the trade occurs if AMZN stock fell to zero. In that case, the trade loses $11,985. With AMZN stock, the likelihood of going to zero is pretty small and most traders would cut losses long before then.
Cash-secured puts are a great way to generate a return on strong stocks, potentially without ever having to take ownership.
If the put does get assigned, the investor takes ownership with a reduced cost base and can potentially begin selling covered calls to generate additional income from the position.
A stop loss could be set if AMZN stock drops 8% from the time of trade entry.
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.
