With oil stocks looking like they might be able to make another run, Schlumberger is on the list of potential setups. According to the IBD Stock Checkup, SLB stock is currently showing a Composite Rating of 97, an EPS Rating of 79 and a Relative Strength Rating of 95.
But maybe you want to buy SLB stock at a lower price. Using a cash-secured put could get you those shares at a discount with less risk.
Buying Stock At A Discount With An Option Trade
A cash-secured put is a slightly less bullish trade than buying the stock outright. It is considered a neutral to slightly bullish trade.
It starts by writing, or selling, an at-the-money or out-of-the-money put option. In this example, we'll be looking at SLB stock. Simultaneously, you set aside enough cash to buy the stock at your chosen strike price.
You win in two ways. Either the put expires worthless and you keep the premium or you get assigned the shares 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.
Traders selling puts should be ready to buy 100 shares at the strike price in case they get assigned.
Setting Up The Trade With SLB Stock
With SLB stock trading at 42.86 yesterday, investors could sell a December put with a strike price of 40 for around $2.20.
An investor selling this put receives $220 into their account. That's theirs to keep.
If SLB stock stays above 40 by Dec. 16, the put expires worthless leaving the trader pocketing that premium for a 5.8% return on capital at risk in just a couple of months' time. That works out to be 35.41% annualized.
But what if SLB pulls back below 40 by expiration? Then as the put seller, you have the obligation to buy 100 shares of SLB stock at 40. However, because of the $2.20 premium received, the effective net cost of the position would be 37.80 per share. That is 11.8% below yesterday's closing price.
Risks And Rewards
The main risk with the trade is similar to outright stock ownership. If SLB stock falls quickly, the trade will suffer a loss. Once you get assigned the shares of SLB, if the stock goes down you're going down with it. However, the premium received for selling the options will help slightly offset the loss in the stock.
The maximum loss on the trade occurs if SLB stock falls to $0. It's unlikely. But even in that worst-case scenario, the trade is still risk defined. At most you lose $3,780 but most traders would cut losses long before then.
A stop loss could be implemented if SLB stock broke below 38.
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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. Plus, you can potentially begin selling covered calls against the SLB stock position to generate additional income.
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.
