by John Jagerson and Wade Hansen | October 5, 2012 8:53 am
Recommendation: Sell to open (short) cash-secured DE Nov 80 puts for a credit of $1.50 or more.
While we’re optimistic about the potential for Deere (), there’s certainly enough volatility in the market to justify a cautious entry into the trade. In addition to our recommendation for buyers to open the trade on a break higher, we think option traders could hedge their way into the trade with a short put. A put option is sold short when traders believe that the stock will either remain flat, bullish or decline slightly.
A short put means that a trader will have to buy the stock for the strike price if its value falls below the strike by expiration. Trading this way means the stock can fall from where it is now before losses have been realized.
We recommend selling to open (shorting) cash-secured DE Nov 80 puts for a credit of $1.50 or more. Traditionally, shorting investment vehicles of any kind means trading in a margin account. If you’re not ready or able to harness the power of margin, doing this as a cash-secured trade is the answer.
Cash-secured put selling simply means your broker knows you have sufficient cash on hand in your account to buy the stock at the strike price. Said another way, if you’re assigned (or “put”) the stock, you can cover that obligation. Since we have a bullish bent on Deere, owning the stock would be happy outcome. If the put is cash-secured, it will reduce the breakeven point on the trade to $78.50, which is at a short-term level of support.
At expiration, if the stock is above the strike price, traders won’t be exercised and could sell the December puts again to collect another premium. If the stock is just below the strike price and the trade is still looking good, short put traders can allow assignment to happen and will have purchased the stock for a cheaper price ($80) than we are evaluating today and will still get to keep the $1.50 premium.
The risk/reward profile for a short put is very similar to a covered call, assuming that the cash needed to cover assignment is left in your account. Leveraged traders can reduce the amount needed to cover margin to a little less than 20% of the notional value of the contract. However, we don’t recommend this because we are using this strategy as a way to (potentially) actually acquire the stock if it drops, and for a lower price than is available now.
Shorting puts should be another tool that savvy traders have in their arsenal to make a bullish bet on a stock — and from where we stand, DE will keep moving up.
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