Sociedad Quimica Y Minera, Tuesday's IBD Stock of the Day, has bounced nicely off the 50-day moving average.
One way to take ownership of a stock for less than the price it is currently trading? Try an option strategy called a cash secured put. This put is a slightly less bullish trade than buying the stock. Consider it a neutral to slightly bullish trade.
SQM Stock: Setting Up The Cash-Secured Put
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: Either see the put expire worthless and keep the premium, or to be assigned the option and acquire the stock below the current price.
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.
It's important that anyone selling puts understands that he or she may be assigned 100 shares at the strike price.
With SQM stock trading at 94 Tuesday, investors could sell an Aug. 19-expiration put with a strike price of 90 for around $6.60.
An investor selling this put would receive $660 into their account which would be theirs to keep. If SQM falls below 90 by Aug. 19, they would be required to buy 100 shares at 90. The effective net cost of the position would be 83.40, thanks to the option premium received.
That's 11.3% below Tuesday's closing price.
Return Vs. Risk
If the stock stays above 90 at expiry, the put expires worthless. That leaves the trader with a healthy 7.9% return on capital at risk.
The main risk with the trade is similar to outright stock ownership. That is, if the stock falls quickly, the trade will suffer a loss. However, the loss will get partially offset by the premium received for selling the put.
The maximum loss on the trade would occur if SQM stock fell to $0. This would see the trade lose $8,340 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 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.
Superb IBD Ratings
According to the IBD Stock Checkup, SQM stock ranks No. 1 in its group and has a Composite Rating of 99, an EPS Rating of 84 and a Relative Strength Rating of 99.
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
