Profit From J.C. Penney's Comeback With This Income Trade
J.C. Penney (NYSE: JCP) bounced from an all-time low of $4.90 in early February. Shares went on to double in less than three months but have since pulled back slightly.
The extreme lows did not see new highs in volatility, representing a bullish divergence. This is a sign that a bottom has been put in place.
The $8 level is a technical price pivot in the wide basing pattern since October. Midpoint support of the $10 to $5 trading channel sits at $7.50.
#-ad_banner-#If you are comfortable holding on to this inexpensive stock for a potential recovery, then selling puts could allow you to collect income while you wait to get into JCP at a 13% discount.
While the typical investor might use a limit order to buy a stock or ETF at a designated price or lower, the options trader can do one better by selling a cash-secured put option.
This strategy has the same mathematical risk profile as a covered call. When selling puts, there is an obligation to buy the stock at the option's strike price if it is assigned, allowing you to get into the stock at a discount. In fact, the true entry cost basis is even lower with the subtraction of the premium you earned from selling the puts.
And if the stock is not below the strike price at expiration, then the premium received is all profit. In other words, you're getting paid not to own the stock.
There are two rules traders must follow to be successful at selling puts.
Rule 1: Only sell put options on stocks you want to own.
The intention of the put selling strategy is to be assigned the stock as a long-term investment. Each option contract represents 100 shares, so make sure you have the funds in your account to buy the stock at the option's strike price if a sell-off occurs. Paying in full ensures that no additional money is needed to hold the stock for potentially many months or even years until a price recovery.
Rule 2: Sell either of the front two option expiration months to take advantage of time decay.
Collect premium each month from selling puts until you are assigned shares at a cost-reduced basis. Every month that you keep the premium is money subtracted from your entry price.
Action to Take --> Sell to open JCP July 8 Puts at $0.35 or better. (Use a limit order to get the desired level of income.)
This cash-secured put sale would assign long shares at $7.65 ($8 strike minus $0.35 premium), which is about 13% below JCP's current price, costing you $765 per option sold. If the put option expires worthless, you keep the $35 premium, earning a potential 4.6% return in 51 days -- which compounds out to an annualized return of nearly 33%.
Remember, you should only sell this put option if you are comfortable owning JCP at a discount to the current price.
If you are assigned the shares, an August covered call can be sold against the stock to lower your cost basis even further. If JCP does not fall below the strike price before expiration, then you keep the premium you collected, essentially getting paid not to buy the stock.
This article was originally published at ProfitableTrading.com:
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
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