Trade of the Day: Lloyds Banking Group (LYG)

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Last week, the market seemed to be shaping up for a breakout event when the Dow Jones and S&P 500 traded to new all-time highs on Monday and then again on Tuesday, as the S&P cleared the technical and psychological resistance level at 1,900. However, the pullback from those highs later in the week shows just how fickle and susceptible investor sentiment is and how quickly the investing landscape can change.

Hedge fund guru David Tepper of Appaloosa Management spoke on Wednesday in Las Vegas at SkyBridge Capital’s SALT Conference and stated that he is nervous about the deflationary environment that is high on the Fed’s list of worries, weaker-than-expected growth in the United States and the European Central Bank (ECB), which badly needs to ease monetary policy.

Starting on Thursday, the market took his tone of caution to task: all of the stock indexes traded sharply lower, while bonds traded sharply higher. The 10-Year Treasury note yield is now down to 2.5%, despite Wednesday’s Producer Price Index reading (up 0.6% for April), Thursday’s Consumer Price Index reading (up 0.3% for April) and Friday’s positive April jobs report.

The diverging trend of improving economic data and declining bond yields has even the smartest people in the room scratching their heads. For many traders, it’s hard to decide what to do next at a time like this — but actually, a pullback like this one is a great time to sell some put premium back to the market and thus cash in on a strong bullish name.

After all, when a stock takes a brief dip, the price of its put options will rise, and vice versa. So, if you’re bullish on that stock, then you can cash in by selling put options for a nice premium…and once the share price enjoys a breakout, that put option will expire worthless. That’s bad news for the put buyer, but profitable for you as the seller, since you’ll keep 100% of your put premium.

In an uncertain environment, it’s also comforting when a company you’ve traded profitably in the past looks like it’s getting ready for another run-up. Lloyds Banking Group (LYG) is just such a winning name that my Cash Machine Trader subscribers have profited from in the past, and it posted better-than-expected Q1 earnings amid discussion that it would resume its common dividend.

LYG shares jumped 10% on the news, hitting $5.55 before coming in to about the $5 level. Technically, the stock should take out the 52-week high of $5.76 on this next run.

My trade recommendation is to “sell to open” the LYG June $6 puts at $0.80 or more per contract, good till canceled. The option symbol is LYG140621P00006000. 

For my naked-put trades, I look to sell put premium on those stocks that have just enjoyed a technical breakout on big volume, then pulled back to the breakout line on light volume. At the nadir of that pullback, I want to sell a naked put with a strike price that’s just higher than where the stock touched its highest point on the fresh breakout spike. And that’s just the setup that LYG is giving us.

That might sound simple to implement – and, in a way, it is. But it’s important to keep in mind that, any time you sell a put option, there’s a chance that the underlying stock will take a further dive. In that case, the buyer will almost certainly exercise the option. Why wouldn’t they, when it gives them a chance to sell you shares at a better price than the current quote?

So, any time I recommend a naked put trade, my highest priority is to know that I have no problem owning the underlying stock if I am assigned the shares. That way, we’ll be able to simply turn around and sell calls against it so that we’d get out with a nice called-away profit. I’ve done so many times before, and as long as the underlying stock cooperates, it makes these naked-put trades essentially a win-win scenario.

But if all goes as planned and LYG rallies above $6 in the next month, then the put buyer would not be interested in exercising the option contracts. (After all, he or she could simply sell the shares for a better price in the open market.) That would mean that those LYG June $6 puts will expire worthless to the buyer…and you’ll walk away with a 100% profit in the form of your put premium, all without ever touching the shares.

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Article printed from InvestorPlace Media, https://investorplace.com/2014/05/lloyds-banking-group-lyg-breakout/.

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