I think it is safe to say that in 2022 small caps, as defined by the Russell 2000 (IWM), have had less than stellar results. But with turmoil comes opportunity.
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 small caps, or any security for that matter, to hit your chosen price. I’m talking about cash-secured puts.
By using cash-secured puts you can 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.
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I take this approach every time I wish to purchase a stock or ETF. 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.
Let’s go over a quick example.
Cash-Secured Puts in ARKK
Let’s say you are interested in buying the ARK Innovation ETF (ARKK), but not at the current price of 45.65.
You prefer to buy ARKK for 37.
Now, most investors would simply set a buy limit at 37 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 37 strike.
If you look at the options chains for ARKK below you will quickly notice that for every 100 ARKK shares we want to purchase at 37, we are able to bring in roughly $1.20, or $120 per put contract sold, every 46 days.
The trade itself is simple: Sell to open September 16, 2022, ARKK 37 puts for a limit price of $1.20.
By selling the 37 put options in September you can bring in $120 per put contract, for a return of 3.2% over 46 days. That’s $840, or 22.4% annually, per contract. You can use the premium collected from selling the 37 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 37. It’s currently trading for 45.65. By selling cash-secured puts at the 37 strike you can lower your cost basis to 35.80. That’s over 21% 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 37–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 37 strike we receive $120 in cash. The maximum profit is the $120 per put contract sold. The maximum risk is that the short 37 put is assigned and you have to buy the ETF for 37 per share. But you still get to keep $120 collected at the start of the trade, so the actual cost basis of the ARKK position is again 37 – 1.20 = 35.80 per share. The 35.80 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.
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