For those interested in dipping your toes into the world of beaten-down growth stocks, there is an options strategy that allows you to get into the space at the price of your choosing.
Best of all, you can collect premium, which is currently at inflated levels, while waiting for tech, or more specifically the ARK Innovation ETF (ARKK), to hit your stated price.
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By using cash-secured puts on ARKK, you are able to produce a steady stream of premium that can be used as a potential source of income or to simply lower your cost basis on the position.
I take this approach every time I wish to purchase stock or ETF. And oftentimes, once I am put shares of the stock, or in this case an ETF, I simply sell covered calls against my newly acquired shares and use the wheel approach going forward.
Why would you ever approach buying a security any other way?
Let’s go over a quick example.
Let’s say you are interested in buying ARKK, but not at the current price of 71.03.
You prefer to buy ARKK for 55.
Now, most investors would simply set a buy limit at 55 and move on, right? But that approach is archaic. Because you can sell one put for every 100 shares of ARKK and essentially create your own return on capital (depending on the strike you choose).
Some say it’s like creating your own dividend and in a way, I kind of agree.
A short put, or selling puts, is a bullish options strategy with undefined risk and limited profit potential. Short puts have the same risk and reward as a covered call. Shorting or selling a put means you are promising to buy a stock at the put strike of your choice. In our example, that’s the 55 strike.
If you look at the options chains for ARKK below you will quicky notice that for every 100 ARKK shares we want to purchase at 55, we are able to bring in roughly $1.38, or $138 per put contract sold, every 45 days.
The trade itself is simple: Sell to open April 14, 2022, ARKK 55 puts for a limit price of $1.38.
So, by selling the 55 put options in April, you can bring in $138 per put contract, for a return of 2.5% over 45 days. That’s $1,104, or 20% annually, per contract. You can use the premium collected from selling the 55 puts either as a source of income or to lower your cost basis.
Just think about that for a second.
You want to buy ARKK at 55. It’s currently trading for 71.03. By selling cash-secured puts at the 55 strike you can lower your cost basis to 53.62. That’s 24.5% below where the ETF is currently trading. And you can continue to sell cash-secured puts on ARKK over and over, lowering your cost basis even further, until your price target is hit.
Or, like most investors, you could just sit idly by and wait for ARKK to hit your target price of 55–losing out on all that opportunity cost and the inflated premium that can help to provide a decent source of consistent income.
In review, by selling cash-secured puts at the 55 strike we receive $138 in cash. The maximum profit is the $138 per put contract sold. The maximum risk is that the short 55 put is assigned and you have to buy the ETF for 55 per share. But you still get to keep $138 collected at the start of the trade, so the actual cost basis of the ARKK position is again $55 – $1.38 = 53.62 per share. The 53.62 per share is our breakeven point. A move below that level and the position would begin to take a loss.
But remember, most investors would have purchased the stock at its current price, unaware there was a better way to buy a security. We rarely take that approach. We know better. We understand we can purchase stocks at our own stated price and collect cash until our price target is hit. It’s a no-brainer.
As always, if you have any questions, please do not hesitate to email me or post a question in the comments section below. And don’t forget to sign up for my Free Newsletter for education, research and trade ideas.