Coca-Cola is a low-beta stock on the Dow Jones Industrial Average that has held up reasonably well in this bear market. Consumer staples often fare better as a defensive play. KO stock also provides a 2.8% dividend yield.
Today, we'll look at how to potentially buy Coca-Cola stock for a discount using an option strategy called a cash-secured put.
Cash-Secured Put Gives You A Discount
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.
A cash-secured put is considered a neutral to slightly bullish trade. It's slightly less bullish than buying the stock outright.
You start by writing (selling) an at-the-money or out-of-the-money put option on KO stock. At the same time, you set aside enough cash to buy KO stock at the strike price chosen. If KO stock doesn't come down to your strike price, the put will expire worthless and you keep the premium.
If it does come below your strike price, expect to be assigned. But that allows you to acquire KO stock below the current price and at even more of discount considering the premium received.
It's important that anyone selling puts understands that they may be assigned 100 shares at the strike price.
Let's fill in some details using KO stock.
Selling Puts On KO Stock
Coca-Cola stock traded at 61.65 yesterday. The Aug. 19 put with a strike price of 60 went for around $1.05.
An investor selling this put receives $105 into their account, which is theirs to keep.
If KO stock stays above 60 at expiry, the put expires worthless. The premium pocketed by the investor is a healthy 1.78% return on capital at risk in 31 days. That works out to roughly 21% per annum.
But what if Coca-Cola falls? If the price falls below 60 by Aug. 19, as the put seller you have the obligation to buy 100 shares at 60. If you don't mind owning KO stock, you've now picked it up at a lower price with the additional discount of the premium received.
Your net cost of the position is 58.95 thanks to the option premium received. That's 4.38 % below yesterday's closing price.
Risks Of The Trade
The main risk with the trade is similar to, but slightly less than, outright stock ownership. If the stock falls quickly, the trade will suffer a loss. However, the loss is partially offset by the premium received for selling the put.
The maximum loss on the trade occurs in the unlikely case that Coca Cola stock falls to $0. The trade loses $5,895 in that case, 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 on KO stock 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, Coca-Cola stock is ranked No. 4 in its industry group and has a Composite Rating of 90, an EPS Rating of 73 and a Relative Strength Rating of 91.
Please 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
