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I was sifting through my charts today and discovered an interesting opportunity in the iShares MSCI Brazil Capped ETF (NYSEArca: EWZ). If you look at the chart below, you’ll notice that EWZ is currently oversold on a short-term basis.
As an options trader, particularly one that prefers to sell options, this is the type of setup that I look for in a trade. The RSI is oversold over several different time frames, (2) and (5), which means that there’s a good chance that a mean-reversion move or reprieve is right around the corner. As a result, I want to sell a few puts on the Brazil ETF.
Selling a put obligates you to buy shares of a stock or ETF at your chosen short strike if the put option is assigned.
For example, let’s say you wanted to buy the EWZ fund, but not at the current price of $24.96. You prefer to pay $21.50.
By selling the May 21.5 puts you can bring in approximately $0.55, or $55 per contract. In this instance, you are selling the put with the intent of buying the stock for $21.50 if, at expiration in roughly 43 days, the stock is trading at or below $21.50.
Selling the 21.5 put requires you to have $2,150 of cash in your trading account.
Typically, selling puts only require 20% of the $2,150, or $430, but retirement accounts and certain brokers require the puts to be cash-secured. And in this case, that would be the $2,150. The return on the trade is 2.6% over roughly 45 days, or 20.8% annually. And if the puts were not cash-secured, the return would be significantly higher.
As you can see from the same options chain below, you have other strike prices where you can sell puts. If you choose to sell a strike closer to the current price of the stock – say, $22.50 – you could bring in even more premium (roughly $82) but the probability of success goes from 75.12% for the 21.5 puts to 67.30% for the 22.5 puts. So, you do have to make a few decisions as to how much risk you are willing to take based on the strike you choose.
Back to our example, we decided to sell the May 21.5 puts for $0.55. The $55 is ours to keep regardless of what occurs with EWZ.
If the stock closes at May expiration above $21.50, we keep the $55 and oftentimes repeat the process by selling more puts, maybe at the 21.5 strike or possibly at a different strike price. It truly depends on where the stock is trading at the time we sell the puts and how much premium we wish to bring in.
If the stock trades for less than $21.50 at May expiration we are assigned the stock for $2,150 (100 shares per put contract sold). Oftentimes when this occurs I will begin to sell covered calls on the stock so there is an ongoing source of income coming in. I take this approach in one of my High Yield Trader portfolios, appropriately named “The Income Cycle.”
Speaking of High Yield Trader, Ian Wyatt and I will be hosting a teleconference on Wednesday, during which we’ll discuss income strategies like the example I just outlined. If you’re interested in joining us for this live event, please click here for more details and to get registered.