Back in May and after a nice start to the year, General Motors Company (NYSE:GM) stock looked technically vulnerable. I dared to catch that knife and it paid off. Now I still see upside potential, so I am willing to reset another bullish trade knowing I have profits in hand.
The outlook for the auto manufacturing sector remains unchanged. Vehicles sales are still impressive, perhaps thanks to low global borrowing rates. I don’t anticipate a drastic drop in sales, since even if central banks tighten lending parameters, there has been a marked improvement in employment. For as long as we have jobs, we will need transportation.
Fundamentally GM stock — with a price-to-earnings ratio under 6 — is cheap in absolute terms. This is well under that of Ford Motor Company (NYSE:F) and Toyota Motor Corp (ADR) (NYSE:TM). So with a price-to-book barely over 1, it’s not likely to be a major mistake to own the shares here.
Click to Enlarge This will play an important role in my thesis today. I am willing and able to temporarily own the shares if the price goes against my trade in 2107.
Technically, with today’s surge General Motors stock is hovering above center-point of its four-year price range. So I could assume that it’s in balance. For the past few years, I’ve heard experts speak of peak auto, but am not too worried about its impact on the mid-term value in GM stock.
Clearly there are potential pitfalls, so today I am merely betting that the downside is limited and therein lies the opportunity. I will generate income out of thin air and with room to spare.
Today’s trade assumption is that the recent dips established the recent bounce levels as solid support. Although my last trade on GM delivered short-term easy profits, today my goal is for a longer time frame.
GM Stock Trade Idea
The Bet: Sell the GM Nov $31 naked put and collect 75 cents per contract to open. Here I have an 80% theoretical chance of retaining my maximum gains that I collect today. But if price falls below my strike, then I have to own the shares and this could result in losses below $30.25.
I will not hedge this trade. I am confident that I can manage my risk against the short term price gyrations.
Not all investors are willing or able to own GM stock, and for those I can modify the trade into a credit spread. This would limit the risk and thereby reduce the margin the setup requires.
The Alternate Bet: Sell the GM Nov $31/$29 credit put spread which can deliver 16% in yield. Both trades have about the same chance of success, but this one only puts a few dollars at risk. In either case, I have a 13% buffer from current levels, leaving much room for error unlike if I buy GM shares out right.
Investing is risky business, so I never risk more than I am willing 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.
