Chipotle Mexican Grill is set to report earnings on Wednesday after the closing bell, and the options market is pricing in a 7.9% move in either direction. Chipotle stock moved higher following four of the burrito chain's last six earnings releases. Only one of the last six saw a bigger-than-expected move on the downside.
With the increased implied volatility typically preceding earnings announcements, we'll look at selling a cash-secured put.
Cash-Secured Put On Chipotle Stock
A cash-secured put involves selling an at-the-money or out-of-the-money put option and simultaneously setting aside enough cash to buy the stock, in case you get assigned.
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.
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It's important that anyone selling puts understands that they may be assigned 100 shares at the strike price.
For Chipotle stock, a trader selling the Aug. 2 put with a strike price of 50 will generate around $95 in premium per contract.
The put has a delta of 25, which means there is a 75% chance that it will expire worthless.
Obligations And Risks
As the put seller, you take on the obligation to purchase 100 shares of Chipotle stock at 50, if called upon to do so by the put buyer.
The break-even price for the trade takes the strike price less the premium received. In this case that gives a break-even price of 49.05.
That's 8.4% below yesterday's closing price and slightly outside the expected move. It's also below the 200-day line for Chipotle stock.
If the stock stays above 50 at expiry, the put option expires worthless, leaving the trader with a healthy 2% return on capital at risk. That works out to around 64% on an annualized basis.
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 will be partially offset by the premium received for selling the put.
Why Cash-Secured Puts?
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 2% return in just a few days, or they get to purchase CMG stock at a reasonable discount on the current price.
If Chipotle stock trades below 50 and the put gets assigned, investors can then sell covered calls against the position to generate further income.
Chipotle stock is ranked No. 5 in its industry group, according to the IBD Stock Checkup. It has a Composite Rating of 90, a stellar EPS Rating of 98 and a Relative Strength Rating of 72.
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
