By using a simple options trade, you can buy this stock at a 15% discount or earn $270 not to. This is the same strategy big money managers use to purchase stocks they like for cheap.
Volatility is OPPORTUNITY…
The crucial measure of payoff for an investment is RETURN on RISK.
Controlling and quantifying risk is the primary job of an investor. Once the worst-case scenario is determined, downside exposure to ANY possible event is calculated in dollar terms. Only then, the financial impact on the portfolio can be weighed
Risk and Probability are the factors that can be controlled using options. The super leverage benefit is secondary to the ability to know the maximum cost of any potential catastrophic stock move.
Crude Oil prices settled at $53 per barrel, more than double the January $26 per barrel.
The higher energy prices have seen U.S. rig counts rise for the eighth consecutive week. According to Baker Hughes, the total active U.S. oil and natural gas rig count rose last week 16% to 653.
Seadrill stock had been slammed from $15 in 2015 to under $2 per share. Sideways action has seen SDRL mostly between $2 and $4 for the last year of trade.
The $3 level is the 2016 move mid-point pivot support to lean on for bulls.
The option volatility at the 110% level makes the option expensive in relative value compared to the market itself. Option selling strategies take advantage of the increased premiums.
The potential return on risk is 7%, which is attractive with a $2.80 breakeven at the option expiration.
Buying at a 15% discount price if assigned is a way to position for a long-term recovery in a single digit stock…. Or to get paid not to buy it at these extreme low levels.
The high implied volatility makes option selling strategies attractive as pure probability trades that utilize time decay acceleration. The May options have three weeks until expiration.
One tactic to buy at a lower price, or get paid not to, is used by money managers to buy stocks that they WANT for long term portfolio positioning. Use others fears for your benefit by selling a CASH SECURED PUT to enter the stock at a major discount.
Option tactics can be employed to make money in Up, Down and Sideways action to take advantage of other variables such as time and volatility.
The fear and uncertainty can be used to get in another 15% lower for those who, at worst, are comfortable holding on to an inexpensive stock to wait for a potential recovery.
The straightforward Price Order to buy a stock at a lower level is common if it can be determined where it is comfortable to get in below current prices. Put in the trade at “X” and wait for the dip to enter.
Professional money managers have certain points at which they would buy a desirable stock, but an option strategy lets them get in at a discount or get paid not to.
Selling a CASH SECURED put has the same mathematical risk profile as a covered call, which would assign the stock long at the option strike price. The true entry basis is actually even lower with the subtraction of the premium.
With the Put sale, there is an OBLIGATION to buy at the strike price if it is assigned.
However, if the stock is not below the strike at expiration, the premium received is all profit. Get in the stock at a discount or get paid not to…
There are two rules that Cash Secured Puts traders need to follow to be successful.
Rule One: ONLY SELL PUTS ON STOCK YOU WANT TO OWN.
Have the funds in the account to buy the stock at a discount if a selloff continues.
The intention is to be assigned the stock. Each option represents 100 shares as a long-term investment. Paying in full ensures that no additional money is needed to hold for potentially many, many months or even years until price recovery.
Rule Two: Sell either of the front two option expiration months to take advantage of time decay.
Collect premium every month on put sales until you are assigned shares at a cost reduced basis. Every month that you keep the premium is money subtracted from the entry price.
Trade Setup: Sell the SDRL January $3.00 Puts to open at $0.20 or better. The cash secured Put sale would assign long shares at $2.70 if it is put to you costing $270 per option sold.
ONLY sell this put if you want to own the shares at a discount to the current price.
The combination of time decay and 70% probability of SDRL finishing above the $2.80 break even make the option sale attractive with three weeks until expiration.
If assigned shares, a February covered call can be sold against the stock to lower the cost basis again when you own it.
If SDRL stock does move lower, buy the shares for 15% cheaper than the current share price.
Otherwise, you get paid not to… and get a 7% return on risk in three weeks.