Coffee is one of those things that never goes out of fashion, and even during a recession, people will still be flocking to Starbucks (SBUX) for their morning cup of Joe. So, as more commuters start to head back to work, Starbucks stock could be one company to benefit from that trend.
Starbucks stock is currently showing a Composite Rating of 79, an EPS Rating of 69, and an RS Rating of 76.
Selling puts on a stock you want to own is one way to generate an income using options.
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 to be assigned and acquire the stock below the current price.
View a cash-secured put as a slightly less bullish trade than buying the stock. Options veterans consider it a neutral to slightly bullish trade.
Selling put options is an easy place for investors to start with options. They are very similar to a covered call and are quite easy to understand, once you know the basics.
Investors selling puts must understand that they may be assigned 100 shares at the strike price.
Let’s take a look at an example using SBUX stock.
Starbucks Stock: Set Up The Cash-Secured Put
With the stock ending at 115.68 Wednesday, investors could sell an Oct. 15-expiration put option in Starbucks stock with a strike price of 115 for around $3.50.
An investor selling this put would receive $350 into their account, which would be theirs to keep. If Starbucks falls below 115 by Oct. 21, they would be required to buy 100 shares at 115. The effective net cost of the position would be 111.50, thanks to the option premium received.
That’s 3.6% below Wednesday’s closing price.
If Starbucks stock stays above 115 at expiry, the put expires worthless, leaving the trader with a healthy 3.14% return on capital at risk. That works out to around 20% on an annualized basis.
Some traders may prefer to wait and see if Starbucks stock pulls back, in which case the October 115 strike put could be sold for a higher price. Alternatively, traders could sell a lower strike put.
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 loss will be partially offset by the premium received for selling the put.
Managing Risk On This Trade
The maximum loss on the trade would occur if SBUX fell to zero, seeing the trade lose $11,150, 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 of Starbucks stock with a reduced cost base and can potentially begin selling covered calls to generate further income from the position.
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
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