We’ve previously detailed in "Know Your Options" the way that selling puts on stocks that you want to own can be a way to generate options profits and/or buy shares at a discount to the current market price. The idea is simple, you sell out of the money puts – especially when implied volatilities are unusually high - and if the stock doesn’t decline lower than the strike price before expiration, you keep the entire premium you collected. If the stock does fall below the strike, the puts are assigned and you purchase the shares for the strike price minus the premium you collected which represents a discount to where the stock was trading when you initiated the trade.
It’s a sophisticated method of “buying the dip.”
You’ll also recall that implied option volatilities tend to increase as stock prices fall. This price mechanism is built into most option pricing models which automatically raise volatility inputs at lower underlying prices on the theory that stock declines happen with greater speed and magnitude than rallies. That theory mostly makes sense and when a company is in serious trouble, the last thing you’d probably want to do is sell puts – even at high vols.
It’s a different story however for solid companies that have simply had a tough stretch. That’s the case right now with Facebook (FB - Free Report) and Apple (AAPL - Free Report) . Both stocks have been punished recently, Facebook because of user privacy issues and the role of its social media platform in election meddling and Apple because of predictions of slowing demand for iPhones. Since hitting new all time highs earlier in 2018, Apple shares are down 23% and Facebook is down 36%.
Predictably, implied volatilities on the options of both stocks have risen. With their large market caps, implied vols in these names are generally just a bit higher than options on the broad indexes in which they carry heavy weight, but that spread has widened lately.
If you were thinking it might be time to add shares of either of these tech juggernauts to your portfolio, this might be a good time to sell puts and capitalize on those higher option premiums.
With Apple trading at $178/share, the January 175 strike puts are trading at $6. That represents an implied volatility of 30% - historically high for Apple. If you were to sell those puts and Apple doesn’t decline further before expiration, you’d pocket $600 per option in profit. If Apple does fall below $175/share, you’d be buying it for a net price of $169/share.
With Facebook at $138/share, the 135 strike puts are trading $5 which represents an implied vol of 33%. In this case you can collect $500 in premium to keep - or if the share price falls further, you’ll own the stock at a net price of $130/share.
In both cases the trade does of course involve some risk, particularly if shares fall precipitously, but in the end, the trade is less risky than simply buying the shares. If you were thinking about buying anyway, this might be a better way to go about it.
As always, you’ll need to make sure that you have the buying power in your brokerage account prior to making the trades and also ensure that you are approved for the options trading level that allows you to sell options. This will vary by brokerage firm.
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