Molycorp Inc (NYSE:MCP), a development-stage company that engages in the production and sale of rare earth oxides, has been hit hard in the past year and a half. After making a 2012 high in April above $35, the stock plunged to an all-time low of $4.70 in April of this year.
The $6 level is important to watch on a weekly closing basis. It held as support in November 2012, and has acted as a price pivot point for the stock since then, with shares trending on both sides.
MCP is currently trading near $7.30, and while cheap is a relative term, I think this stock qualifies with plenty of upside potential. Midpoint resistance from the 52-week high to low sits near $8.50.
If you are comfortable holding on to this inexpensive stock for a potential recovery, then selling put options could allow you to collect income while you wait to get into MCP at a 9% discount.
Cash-Secured Put Selling Strategy
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 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 One: 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 Two: 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.