Option Selling Ideas To Consider And Some To Avoid

Option selling is a technique that professionals use to generate more income to portfolios and manage risk.

Selling covered calls to take some premium income and set a price to sell a stock at should it rise further is a strategy that millions of investors already employ. Selling cash-secured puts in an era when many investors have excess cash is a strategy that can add cash to portfolios and set buy prices lower than today’s prices on stocks that you would like to own.

At my firm and at Margin of Safety Investing, we look for times when stocks we own are overbought to sell covered calls. We also look for times when stocks we like are oversold to sell cash-secured puts.

Consider my ideas in the context that I believe there could be a year-end into January rally, and that I also think that time period will be a good time to lighten up on equity investments. It is my belief that sometime in Q1 2020, the stock market begins to head into correction mode similar to – or more severe than – that seen in the second half of 2018.

If you are concerned about reducing risk and would also like to get some of the gains of any rally, here are several of our Very Short Lists stocks that you can sell covered calls on. There are also several cash-secured put ideas among the oversold stocks that we like for the long term.

Overbought Stocks To Sell Calls On

There are currently about 250 combined companies on our Very Short Lists of stocks. These are made up of our favorite companies – those that we’ve researched and decided not to elevate to our favorites, those that were removed and those at the front end of being examined. If there is a company that we previously covered or that is popular in general that you’d like me to look at, please mention it and I will add it to this watchlist.

Overbought stocks to consider selling covered calls on.

We discussed Calix (CALX) on our most recent free Friday webinar. I have not been able to read its earnings release transcript yet, unfortunately. This is a company we have been waiting to see if its 5G-related products get traction. If it becomes a leader in connectivity, the ramp is long and steep. The stock could run quite a bit higher from current prices.

This is a stock that we likely want to buy on the dips if it is a winner. Owners could sell covered calls on a portion of a position. If called away, the volatility is high enough to sell cash-secured puts again to reestablish a full position.

CALX is trading for about $7.75 now. The CALX January $8 call is selling for about 45¢ right now. That is a solid 5% plus premium plus another 2.5% or so capital gains for about 3 months’ holding time. The cumulative gain of 7.5% for 3 months is very solid when annualized to around 30%.

Apple (AAPL) has been a market darling this year. The stock is quite overbought on the recent rally. But this is a case of a great company that pays a decent dividend. Getting rid of the position is difficult.

That said, the AAPL January $250 calls are trading for about $8. That’s a shade above a 1% per month premium, and the stock would have another $7 plus to rise before being called away. Selling this call yields a bit over a 6% return for 3 months. If you are overweight AAPL, this is a reasonable way to take a little money off the table.

Intel (INTC) is the stock I have a bet with a member that it would be above $40 per share through this year. That’s looking pretty solid to happen. Semiconductors, though, are susceptible to economic slowdowns, so I am interested in skimming a little premium here and leaving a little more room to run.

The INTC January $60 call is trading for about 80¢. This isn’t super sexy, but it’s something, and it allows the stock to run another $3.70 or so. That’s a total return of $4.50 in 3 months, or a bit over 8%.

Nvidia (NVDA) is also in the semiconductor boat. However, its AI platform is superior and widely used. We are just at the start of the AI revolution, so this is a stock you want to buy on pullbacks.

If you have the stock and it’s a full 100 share position (tough to have on stocks like Apple, Nvidia and other stocks in the hundreds or thousands for price), then the NVDA January $210 call with a premium of about $11 is attractive. That allows a ramp of another $7 before it is in the money. A total return of $18 against the current price of nearly $203 yields a 3-month return of almost 9%.

If you do not have a portfolio where periodically selling covered calls on overbought conditions makes sense for you, or you want to rein in risk further, then trimming positions back makes a lot of sense. As we’ve covered several times now, the post-January set-up is looking weaker and weaker for the stock market, so selling into Holiday and January strength could be very worthwhile.

Cash-Secured Puts To Consider

We never use margin and only sell cash-secured puts on stocks we would like to own. Below are the stocks of companies we have studied or recommend on our “Very Short Lists” rank ordered by oversold Relative Strength, or RSI.

Oversold VSL stocks worth cash-secured put consideration.

The name at the top of the list is Twitter (TWTR). We were originally in this name when it was in the single digits and sold out for roughly a double. Since then, we have not paid the stock much attention, which was probably a bit of a mistake.

If you believe Twitter has a bright future, as I do, then looking at building a position on this pullback makes sense to me. The question is how far down can it go. That’s always a concern when selling a cash-secured put, just like there is when buying a stock outright at current prices.

Twitter has literally fallen off a cliff. Usually, there are a few tumbles further down the hill when that happens to a stock.

Twitter could see the $15-25 price range soon.

There is a first level of support for Twitter in the middle $20s, and that is probably where I would look to sell cash-secured puts if I am interested. The floor looks to get all the way to the middle teens potentially, so I don’t want to be too aggressive here.

iRobot Corp. (IRBT) is another stock that has been knocked off of its mountain. Unlike Twitter, it seems to be closing in on a bottom. That said, I’m not terribly interested in trying to catch a falling knife and would like to see a couple weeks’ sideways movement.

Interestingly, the daily and weekly money flows seem to be signaling that some investors are starting to move in. Daily charts aren’t always great signals for longer-term buys, but the weekly is. If it continues trending higher, that is a good sign.

iRobot daily chart. Money flow is moving higher, but it’s been very volatile.

iRobot weekly chart. Money flow might have bottomed and be rebounding on the deeply oversold RSI condition. I’d like to see a stable price and more money flow into the stock before committing my investment dollars.

Boeing (BA) has been getting taken to the woodshed. There is a lot of technical damage to the stock, and I have been in the camp for months that things were going to get very bad for the company in the short term.

Longer term I like Boeing, as there is a lack of capacity for plane production in the world. The company will benefit from that. Smart investors should be learning as much about the company as possible and looking for a pivot point somewhere lower, in my opinion.

First Solar (FSLR) is a company of the future that utilities are going to pay a lot of money to. The Buy range on FSLR appears to be the lower $50s to lower $40s. We are near the upper end of that range now.

Shorter-term traders have been selling FSLR off.

However, longer-term owners do not seem terribly deterred and money flow has barely budged. That is a good sign. It’s hard for me to see this stock getting below middle $40s given their strong balance sheet and growth profile.

If the stock falls to about $50, I would be inclined to sell $50 puts a couple of months out. Why? The premiums are pretty plump because it’s a solar name. I would be a buyer in the middle $40s as well, so I’d be using a dual approach to entry.

CF Industries (CF), like our favorite fertilizer Nutrien (NTR), is another solid company with a good long-term outlook that’s been treading water but paying a good dividend.

Our “bottom-fishing price” for CF stock for our low vol retiree dividend investors is $35 per share, so I am laying off. If the stock falls into the $30s, then there is very strong reason to build a position, in my opinion, given my favorable outlook on fertilizer stocks in that oligopoly world.

Texas Instruments (TXN) is a Dividend Sleuth (one of our analysts) favorite and finally near a buy zone. I like that it has moved sideways lately.

The weekly money flow suddenly stabilized on that price drop. I have watched and known Texas Instruments since the late 1990s. Dips are almost always a buying opportunity for dividend growth investors.

In this case though, I think the recent buyers are just conditioned to buy. TXN isn’t a value by metrics yet. I can see another dip coming potentially into the $90s. While I like the possibility of a year-end into January rally, I don’t see real value here yet.

We’ll finish up this week with SunPower (SPWR). We originally bought between $5 and $7 per share, and have taken some profits. The stock has pulled back.

As I discussed in a few pieces, SunPower has a bright future. It is a leader in commercial solar and is set up to be a leader in residential. Its ability to a part of microgrids bodes well for the company. California is already starting to realize that microgrids are a big part of the energy future.

For those first learning about SunPower, remember that it is majority owned by energy major Total (TOT). This means the company’s financials are much better than they appear, and really, its financials have gotten much better the past couple years as I suggested would happen.

I like the growth profile here and the chance to buy under $10 again. This is a stock that I suggested – like I said Exact Sciences (EXAS) could do several years ago – could reach $100 per share someday.

The stock has a wide range on this bottoming process. It could reach around $5 per share again, though it looks like $8-ish is a very strong support region. Money flow on the weekly hasn’t ticked back up yet, so that is a cause for caution.

The SPWR January $9 puts are trading at about a buck. This would put a buy price at $9 with actual cost about $8. Selling the $9 put means you are more likely to have the stock put to you. If you do not own the stock or much of it, I think that makes sense.

If you are concerned about SunPower’s price heading lower than $8 per share, hold off on selling a put until there is more clarity. Or, sell a smaller cash-secured put position and hold back money to scale in lower if necessary.

Selling puts on a growth stock like SunPower is, to my way of thinking, a way to add a “synthetic dividend.” That is, you are receiving an income, like a dividend provides, but you are creating it by your trading activity. I, for one, like the control that yields.

Closing Investment Thoughts

As you have seen, just because a stock is oversold in the short term (daily charts) does not necessarily mean it’s a buy. Always compare daily and weekly charts. Very often I look at monthly charts as well, since I am a “position trader” holding most positions over a year.

Selling covered calls and cash-secured puts are both risk management tools when used properly. The additional income is actually secondary. If you remember that, then being an option seller is a very professional way to augment returns and mitigate risk.

In this environment, where many people have chased yield on high-dividend stocks, I implore you to place quality over yield.

Our analysis suggests that fully one-third of dividend stocks in the S&P 500 are at risk of dividend cuts and massive stock price drops in the coming years. Another third of the S&P 500 dividend stocks, in my opinion, could drift lower in stock price as they struggle to maintain dividend policies.

Option selling, used for risk management and additional income, can be a retiree’s best friend. As always, mind your asset allocation and manage risk first.

Build a Margin of Safety into your investing process in this changing and sometimes dangerous world. Benefit from insights and research by Kirk Spano, Dividend Sleuth and David Zanoni.

Take a free trial now and qualify for a 20% discount and get to look at our Q3 “Very Short Lists” spreadsheet that covers our top investment ideas.

Disclosure: I am/we are long SPWR, INTC, NTR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I own a Registered Investment Advisor, but publish separately from that entity for self-directed investors. See relevant terms and disclaimers at the website of Bluemound Asset Management, LLC. Any information, opinions, research or thoughts presented are not specific advice as I do not have full knowledge of your circumstances. All investors ought to take special care to consider risk, as all investments carry the potential for loss. Consulting an investment advisor might be in your best interest before proceeding on any trade or investment.

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