Schlumberger is set to report Q3 earnings on Friday before the market open and the options market is pricing in a 3.3% move in either direction.
Today, we're looking at selling a cash-secured put to take advantage of the high implied volatility around the Q3 earnings announcement.
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.
The goal is to either have the put expire worthless and keep the premium. Or, traders can 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.
Traders May Need To Buy Shares
It's important that anyone selling puts understands that they may be assigned (i.e., forced to buy) 100 shares at the strike price.
For Schlumberger — which has rebranded itself as SLB — a trader selling the Oct. 20 put with a strike price of 60 will generate around $0.90 in premium per contract.
The put seller would have the obligation to purchase 100 shares of SLB stock at 60 if called upon to do so by the put buyer.
The break-even price for the trade can be calculated by taking the strike price less the premium received. In this case the break-even price is 59.20. That's 1.73% below Tuesday's closing price.
If the stock stays above 60 at expiry, the put option expires worthless. That leaves the trader with a generous 1.52% return on capital at risk. That works out to around 185% on an annualized basis.
Risk Of Big Drop After Q3 Earnings
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.
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 1.52% return in three days, or they get to purchase SLB stock at a reasonable discount to Tuesday's price.
If SLB trades below 60 and the put gets assigned, investors can then sell covered calls against the position to generate further income.
SLB Leads Its Industry
According to the IBD Stock Checkup, SLB stock is ranked No. 1 in its industry group and has a Composite Rating of 99, an EPS Rating of 89 and a Relative Strength Rating of 89.
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
