Cisco Systems broke out to a new high last week and has been showing strong relative strength. Cisco stock, a Dow Jones Industrial Average member, currently pays a 3% annualized dividend yield.
Therefore, investors looking to purchase CSCO stock can potentially do so at a discount by using an options strategy called a cash secured put.
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? Either have the put expire worthless and keep the premium. Or get assigned by the option buyer, then acquire the stock below the current price.
Think of this trade as similar to a covered call. Sellers of put options understand that they may be assigned 100 shares per contract at the strike price.
Cisco Stock Today: The Cash-Secured Put Trade
So currently for Cisco stock, a trader selling the June 16-expiration put with a 50 strike price could generate around $1.30 in premium per contract. Then, the put seller would have the obligation to purchase 100 shares of Cisco stock at 50 if called upon to do so by the put buyer.
The break-even price for the trade? Calculate it by taking the strike price less the premium received — in this case, the trade gives a break-even price of 48.70. This marks a level almost 6.9% below Friday's closing price.
The maximum loss on the trade would occur if Cisco stock fell to zero. The trade would lose $4,870. But IBD investors know to cut losses quickly, ideally at 7% or less, to avoid such damage to the portfolio.
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Risk Vs. Reward
If the stock stays above 50 at expiry, the put expires worthless. This leaves a healthy 2.67% return on capital at risk. To get this return, take the $130 premium received, divided by the $4,870 capital at risk. That works out to around 13% on an annualized basis in this Cisco stock trade.
The main risk with the trade? Similar to outright stock ownership. If shares fall precipitously, the trade will suffer a loss, however the loss will be partially offset by the premium received for selling the put.
Cash secured puts are a fantastic way to generate a nice return on stocks the trader is happy to own. Sometimes with a trade like this I'll set my order higher than the current price, say $1.50 in this case and try to generate a bit more premium. If the stock drops a little, it can allow you to get filled at a better price.
IBD Stock Checkup notes that Cisco stock ranks 6th in its group and has a Composite Rating of 86, an EPS Rating of 73 and a Relative Strength Rating of 83.
Remember that options are risky and investors can lose 100% of their investment.
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
