Nike is set to report earnings on Thursday after the market close. The options market is pricing in a 6% move in either direction. So, let's look at selling a cash-secured put in Nike stock to take advantage of the high implied volatility around the 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 Dow Jones Industrial Average stock.
The goal? Either have the put expire worthless and keep the premium, or take assignment and acquire the stock below the current price.
This strategy is very similar to a covered call and quite easy to understand once you know the basics.
It's important that traders selling put options understand they may be assigned 100 shares at the strike price.
Nike Stock Today: Setting Up The Trade
For Nike stock, a trader selling the Dec. 22-expiring put option with a strike price of 118 will generate around $2.10 in premium per contract, based on recent trading. The put seller would have the obligation to purchase 100 shares of Nike stock at 118 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, which in this case gives a break-even price of 115.90.
That's almost 4.7% below Friday's closing price.
A 132% Annualized Return
If Nike stock stays above 118 at expiry, the put option expires worthless, leaving the trader with a generous 1.81% return on capital at risk. That works out to around 132% on an annualized basis.
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, traders either generate a 1.81% return in five days, or they get to purchase NKE stock at a reasonable discount to Friday's price.
When This Happens
If Nike stock trades below 118 and the put gets assigned, investors can then sell covered calls against the position to generate further income.
According to IBD Stock Checkup, NKE ranks seventh in its group. It holds a Composite Rating of 89, an EPS Rating of 60 and a Relative Strength Rating of 79.
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
