6 Options to Play a Market Bounce

by OptionsZone Experts | February 23, 2011 5:15 am

Sell a Put on a Stock You Want

Decision Time 185

Source: iStock

Decision 185

The market has rallied nearly 25% just since August, lifting up a number of solid stocks. Now, many option trading[1] investors are wondering if stocks are overbought. Oil prices continue to rise and there’s talk the federal government could shut down. Investment gurus have said the market could be in for some consolidation before moving higher.

Selling a put option is one way to play a market consolidation and rally.  Selling a put is a bullish strategy where the trader locks in a purchase price on a stock and collects the option premium. In a nutshell he’s saying, “I’d love to buy XYZ. I just want to pay $5 or $10 less than the current price.” If the stock does fall, the put seller will buy the stock and profit if it returns upward.

Here are six stocks and put selling ideas our option experts have recommended as a strategic way to profit from a market consolidation and rally.

Keep in mind that many brokerage firms have restrictions on the selling of put options. Check with your broker for its policies on your account.

 

Lululemon Athletica (NASDAQ: LULU)

Lululemon logo

Lululemon Logo

Recommended by: Chris Johnson and Jon Lewis, Editors, The Winning Edge[2]

This retailer of high-end fitness gear for women has been a monster performer, gaining around 160% in less than six months. It has a stellar earnings track record – LULU[3] has never missed an earnings estimate in its short public history, including a 44% upside surprise in its last report in December.

The stock pulls back after strong spikes higher, and this appears to be one of those times. But option prices remain rich thanks to the huge uptrend, making this a perfect time to sell a LULU put.

We like selling the LULU March 75 put, which is about 7% out of the money. But you can still collect around $1.35 or so of premium out of this front-month option. We also like this option because a pullback below the 75 strike would bring the rising 50-day moving average into play. This potential support would make an excellent entry point to buy the stock.

This trade requires a little more than $1,200 in margin for each contract sold. Thus, the return on margin should the stock remain above 75 through March expiration (March 18) is around 11%. The breakeven point on this trade is a stock price of $73.65. That represents a 9% decline from the current price.

 

 

Priceline (NASDAQ: PCLN)

 

Priceline.com logo

Priceline Logo

Recommended by: Chris Johnson and Jon Lewis, Editors, The Winning Edge[2]

This is a high-dollar trade because PCLN[4] is an expensive stock, trading around $440. That means buying the shares if they are put to you will be costly as is the margin needed to sell a put. But the premium received will be higher, as is the return on margin.

The stock has gained around 160% over the past eight months, punctuated by pullbacks to the 20-day and 50-day moving averages. The 50-day has supported pullbacks in December and January. This trend line currently resides at the 428 level, or about 2.5% below the stock price. We like selling the PCLN March 425 Put, which currently provides around $19 on the bid.

The margin required for this trade is steep – right around $9,200 per contract. But that means the trade is yielding a return of 20% on margin, not bad for being open for just four weeks. The breakeven point is a stock price of $407, which is 7.3% below the current price.

A pullback similar to recent declines should be supported by the 50-day moving average, which would keep this put out of the money, allowing you to retain the rich $1,800 collected per contract.

 

 

Apple (NASDAQ: AAPL)

Apple Logo B&W

Apple logo B&W

Recommended by: Jim Woods[5]

I love just about everything there is to love about consumer electronics giant AAPL[6]. I personally own an iPhone 4, an iPad and an iPod, and soon I’ll be upgrading my home office with the latest Macintosh computers. About the only thing I don’t own right now is AAPL shares. One key reason is because the stock has had a 12-month run of 75%-plus gains and I think AAPL is due for a bit of consolidation in concert with the inevitable market pullback.

 

I want to own AAPL for the long haul, as its über-strong fundamentals are perfectly suited for this strategy; however, I want to own the stock at a discount to its current price of $350. By selling the AAPL Mar 350 Put, I can collect my premium, and if I am put the stock, I own the shares at a substantial discount to $350 due to the premium I’ve already collected.

Home Depot (NYSE: HD)

Home Depot logo

Home Depot Logo

Recommended by: Jim Woods[5]

Another company I love to patronize is HD[7]. Apparently a lot of people feel the way I do, as the company just released its fourth-quarter earnings that showed a 72% increase in profits, and its strongest U.S. comparable-store sales growth in five years. The news caused the price of HD shares to surge to nearly $40 in pre-market trade on Tuesday, Feb. 22.

I want to own HD shares, but I want to get them at a discount to that $40 price tag. So, I can sell the HD Mar 40 Puts, collect my premium, and if I get put the stock, I own it at a nice discount. Now that’s what I call smart bargain shopping!

 

 

OpenTable (NASDAQ: OPEN)

Open Table

Open Table logo

Recommended by: Michael Shulman, Editor, Short-Side Trader[8]

A classic bubble stock of a wonderful company, OPEN[9] is a blowup waiting for an earnings miss or market selloff. The company is a Web-based restaurant reservations system that customers use to book tables. The site rewards people for showing up, and punishes them for not showing up and not canceling. Restaurants love it because it drastically reduces “no shows.”

There’s nothing wrong with the service or the company. That said, the stock is selling for more than 150 times earnings and the $2 billion market cap rests on $4 million in quarterly earnings. The stock has almost quadrupled since going public less than two years ago. If you think a correction is coming, look at the March 80 or 75 strike out-of-the-money puts.

This is a high-risk, high-reward trade that is contingent on a market correction.

Salesforce.Com (NYSE: CRM)

Recommended by: Michael Shulman, Editor, Short-Side Trader[8]

Sales Force logo

Sales Force logo

CRM[10] is another great company with a great product and an insane, bubble-like valuation more than likely to correct more steeply than the market.

Do I exaggerate? The company has an almost $19 billion market cap based on a P/E around 250. The economy may be rebounding but  Salesforce would have to double profits and double them again, and have its stock trade sideways, and it would still be trading at a huge premium to its peers in the business software segment. With traders having made so much money on the stock in the past two years, it is a likely victim of a sell-off if the market corrects. Look at out-of-the-money 130 or 125 puts on March or May expiration options, depending on your appetite for risk.

This is a high-risk, high-reward trade that is contingent on a market correction.

Endnotes:

  1. option trading: https://investorplace.com/options-trading/
  2. Chris Johnson and Jon Lewis, Editors, The Winning Edge: https://investorplace.com/30684/6-valentine%e2%80%99s-day-options-to-love/30173/option-trades-osk-pnc-ko-slv-lvs-nbl-glw-sfd/author/chris-johnson/
  3. LULU: http://studio-5.financialcontent.com/investplace/quote?Symbol=%20LULU
  4. PCLN: http://studio-5.financialcontent.com/investplace/quote?Symbol=PCLN
  5. Jim Woods: https://investorplace.com/author/jim-woods/
  6. AAPL: http://studio-5.financialcontent.com/investplace/quote?Symbol=AAPL
  7. HD: http://studio-5.financialcontent.com/investplace/quote?Symbol=HD
  8. Michael Shulman, Editor, Short-Side Trader: https://investorplace.com/30684/6-valentine%e2%80%99s-day-options-to-love/30173/option-trades-osk-pnc-ko-slv-lvs-nbl-glw-sfd/author/michael-shulman/
  9. OPEN: http://studio-5.financialcontent.com/investplace/quote?Symbol=OPEN
  10. CRM: http://studio-5.financialcontent.com/investplace/quote?Symbol=CRM

Source URL: https://investorplace.com/2011/02/6-options-to-play-a-market-bounce/