Procter & Gamble Co (NYSE:PG) is supposed to be a boring company to trade. It is a mature global corporation which sells products in 180 countries and across several segments, so it’s as diversified as one can get. Diversification should, in theory, smooth out the stock performance, yet …
This has not been the case for PG. In the past 12 months the stock has swung violently. Today, I will share a trade that would capitalize on this nervousness in the market.
Procter & Gamble, much like its major competitors, is not bloated. It trades at a price-earnings ratio of 25 and carries a price-book barely over four. So owning the shares at these levels is not likely to be a major mistake.
This is an important assumption in today’s trade, as I am willing and able to own the shares in the event my trade fails. I will sell downside risk to generate income with no out-of-pocket risk.
I am a believer that expectations sometimes matter more than actual value. In PG’s case, analyst ratings are humble as most have it as a “hold.” So the chances of a downgrade are low and if there is to be a surprise it’s likely to be upside potential.
Click to Enlarge Technically, PG is only 3% higher than 12 months ago. This is a marked underperformance relative to equity markets in general.
Furthermore, the stock has seen its fair share of volatility. For a company this mature it’s surprising to see two separate +/-10% moves in mere weeks.
Wall Street almost always overshoots in either direction. Last December, traders rejected PG at $81 as too low, then around March at $91 as too high. Somewhere in the middle lies the truth and that’s where we are now. PG stock around $87 should be close to balance.
But I still don’t trust these markets. We are too close to equity all-time high levels, which makes for too many weak hands. If markets correct then PG could still revert to lows. So instead of buying the shares at face value and without any protection, I will sell downside risk below support to generate income.
The Bet: Sell the PG stock Oct $80 put and collect 80 cents to open the risk. This is a bullish trade that has a 90% theoretical chance of delivering maximum gains. But if for some reason price falls below my strike, then I must own the shares and would suffer losses below $79.20.
It is important that I recognize the danger that looms around the $86 level, which could invite momentum sellers if lost. Then the low $80s could come fast.
Selling naked puts is risky and requires large margin especially into an earnings event. To mitigate the risk, I can use spreads instead.
The Alternate Bet: Sell the PG stock Oct $80/$77.50 credit put spread where I have about the same chances of success, but with much less risk. Yet, if the trade is successful it can still deliver 13% in yield. Without options I would need to risk almost $88 and hope for a 13% rally to new all-time highs just to match the performance of the spread.
Investing is inherently risky, so I never expose my portfolio to losses that would break me.
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.
