Dropbox closed at the high at the end of the day on Friday and is sitting nicely above the 50-day moving average. So, let's see how to potentially buy Dropbox stock for a discount via an option strategy called a cash secured put.
A cash secured put is a slightly less bullish trade than buying the stock. Consider this strategy as a neutral to slightly bullish trade.
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 shares and acquire Dropbox stock below the current price.
Selling put options is an easy place for investors to start out with options. They are very similar to a covered call and are quite easy to understand once you know the basics.
Traders selling puts must understand that they may be assigned 100 shares per contract sold at the strike price.
Dropbox Stock Today: The Setup
Let's take a look at an example using DBX stock.
With the stock at 28.78 in recent trading, investors could sell an April 19-expiration put with a strike price of 28 for around $1.30 per share. Thus, an investor selling this put would receive $130 into their account, and it would be theirs to keep.
If Dropbox stock falls below 28 by April 19, they would be required to buy 100 shares at 28. The effective net cost of the position would be 26.70 thanks to the option premium received. That's 7.23% below Friday's closing price.
If the stock stays above 28 at expiry, the put expires worthless. The trader seals a healthy 4.9% return on capital at risk in 138 days. That works out at around 13% per annum.
The main risk with the trade? Similar to outright stock ownership. That is, if the stock falls quickly, the trade will suffer a loss, however the loss will be partially offset by the premium received for selling the put.
Dropbox Has Strong Overall Rating
The maximum loss on the trade would occur if Dropbox stock fell to zero. Then, the trade would lose $2,670 but most traders would cut losses long before then.
Cash secured puts are a wonderful way to generate a healthy 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 further income from the position.
According to the IBD Stock Checkup, Dropbox stock is ranked number 5 in its group and has a Composite Rating of 98, an EPS Rating of 98 and a Relative Strength Rating of 90.
It's important to 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
