Walter Energy, Inc. (NYSE:WLT) is becoming a go-to income play for us. Since early July, we’ve profited twice from this downtrodden coal stock (here and here). And we now have another high-probability opportunity presenting itself.
This volatile stock fell more than 75% from its February high at $40.60 to a low of $9.88 in late June. Since hitting that low, WLT has rebounded past its 2008 lows near $11, which is a pivot price level and should act as support on a monthly basis.
Since the June lows did not correspond with new highs in volatility, this represents a bullish divergence and supports the case that WLT has made a price bottom.
If you are comfortable holding on to this inexpensive stock for a potential recovery, then sellingput options could allow you to collect income while you wait to get into WLT at a 20% 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.
This strategy has the same mathematical risk profile as a covered call. With a put selling strategy, 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 put options.
Rule One: Only sell puts on stocks you want to own.
The intention of this 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 options 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 every month on put sales until you are assigned shares at a cost-reduced basis. Every month that you keep the premium is money subtracted from your entry price.