Freeport-McMoRan broke above the 50-day moving average Tuesday and is showing improving relative strength.
Rather than buying the stock outright, we could sell a cash-secured put to generate some income, or buy the stock for lower than it is trading today.
A cash-secured put is a slightly less bullish trade than buying the stock. It is considered 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 is to either have the put expire worthless and keep the premium, or be assigned 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 understand that they may be assigned (i.e., be required to buy) 100 shares at the strike price.
Option Trading Using FCX Stock
Let's look at an example using Freeport-McMoRan stock.
With the stock closing at 39.82 Tuesday, investors could sell an August put with a strike price of 39 for around $2.05.
An investor selling this put would receive $205 into their account, which would be theirs to keep. If FCX falls below 39 by Aug. 18, they would be required to buy 100 shares at 39. The effective net cost of the position would be 36.95, thanks to the option premium received.
That is 7.21% below Tuesday's closing price.
If the stock stays above 39 at expiry, the put expires worthless, leaving the trader with a 5.55% return on capital at risk.
Option Trading: Cash-Secured Put Can Return 30%
That works out to be 30.68% annualized.
The main risk with the trade is similar to outright stock ownership: If the stock falls quickly, the trade will suffer a loss. However, the premium received will help to offset the loss.
The maximum loss on the trade would occur if Freeport shares fell to $0, which would see the trade lose $3,695. But most traders would cut losses long before then.
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 and can potentially begin selling covered calls to generate additional income from the position.
According to the IBD Stock Checkup, Freeport-McMoRan is ranked No. 9 in its group and has a Composite Rating of 47, an EPS Rating of 12 and a Relative Strength Rating of 71.
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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
