Since the U.S. 2016 elections, the equity markets have been on a tear. We’ve seen new record highs almost everywhere. Experts labeled it as “animal spirits” markets and in this case the description fits. 3M Co (NYSE:MMM) serves as an apt example of the rally. Its stock rallied 30% in 154 bars with almost no dips.
Fundamentally, and even after this mega rally, 3M stock is not expensive from a price-earnings perspective. It also pays a nice dividend and delivers with respectable net profit margins. This is to say that the stock is not bloated.
As long as markets in general hold, MMM is likely to avoid sustainable dips. If and when they come, they shall remain shallow in nature and buyers will step in when they occur.
Click to Enlarge Technically, it’s never ideal to chase a stock long after such a steep rising wedge. But with no dips, I have to plug my nose and do it. No, I won’t buy MMM stock at face value and with no room for error.
Instead I will use options. There I can build some buffer from current price just in case it turns out that I am too late to the party.
MMM Stock Options
The Bet: Sell MMM Jan 2018 $165 naked put and collect $1.50 per contract to open. This is a bullish trade with 90% theoretical certainty that I will retain my maximum gains. If price falls below my strike, I will need to own the shares and accrue losses below $163.50.
Usually, I like to balance my risk by selling upside risk. But in this case I won’t. MMM proved it’s capable of maintaining the rally indefinitely. Besides, I am confident that with a 20% buffer from current price and the time until expiration I will be able to manage my risk against short-term price gyrations.
If selling naked puts is not possible, I could use spreads instead. The bull put spread carries limited risk, so it will require smaller margins.
The Moderate Bet: Sell MMM Jan 2018 $175/$170 credit put spread where I have similar odds of success. The smaller risk limits the absolute dollar reward, but still delivers 5%-plus in yield. The alternative would mean that I have to risk $210 here and hope for a 5% rally without any margin for error.
Selling options is risky, so I never risk more than I am willing and able to lose.
Learn how to generate income from options here. Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him on Twitter at @racernic and stocktwits at @racernic.