Bullish On AMC? Consider A Cash-Secured Put Option
We recently introduced two exchange-traded funds (ETFs) that could be appropriate for investing in one of the most widely-followed meme stocks, movie theater operator AMC Entertainment (NYSE:AMC). Since the start of the year, AMC shares are up about 2,400%, boosted by retail investor enthusiasm.
In the initial months of the pandemic in 2020, the shares had slumped. Yet, the stock’s fortunes started to change when it caught the attention of traders on social media platforms like Reddit and Twitter. Earlier in 2021, AMC stock rallied amid a short squeeze. The stock price exploded in a matter of weeks. Its 52-week range has been $1.91-$72.62.
Today, we look at AMC stock to see how investors could consider selling cash-secured put options on the company. Such a trade could especially appeal to those who want to receive premiums (from put selling) or to potentially own AMC stock for less than its current market price of $52.61, as we write on Tuesday.
Selling Cash-Secured Puts On AMC Stock
Investors who write cash-secured puts are typically bullish on a stock during the timeframe that extends to the option expiry date. They generally want one of two things. Either to:
1. Generate income (through the premium received by selling the put), or
2. Own a particular stock, but find the current market price per share (i.e., $52.61 for AMC now) higher than what they'd like to pay.
One put option contract on AMC stock is the option to sell 100 shares. Cash-secured means the investor has enough money in the brokerage account to purchase the security if the price of the stock falls and the option is assigned.
This cash reserve must remain in the account until the option position is closed, expires or the option is assigned, which means ownership has been transferred.
Let’s assume an investor wants to buy AMC stock, but does not want to pay the full price of $52.61 per share. Instead, the investor would prefer buying the shares at a discount in the next six to 10 weeks.
One possibility is to wait for AMC stock to fall, which it might or might not do. The other possibility is to sell one contract of a cash-secured AMC put option.
As a result, the put seller would take on the obligation to potentially buy 100 shares of AMC at a certain price (the strike price) by the expiry date, and get paid a certain amount of premium now for taking on that obligation.
So the trader would typically write an at-the-money (ATM) or out-of-the-money (OTM) AMC put option and simultaneously set aside enough cash to buy 100 shares of AMC stock.
Let’s assume the trader is putting on this trade until the option expiry date of Aug. 20. As AMC stock is currently $52.61, an OTM put option would have a strike of 50. The seller would have to buy 100 shares of AMC at $50.00 if the option buyer were to exercise the option to assign it to the seller.
The AMC Aug. 20, 2021, 50.00-strike put option is currently offered at a hefty price (or premium) of $17.65.
Readers following the options markets would have noticed that AMC stock’s realized and implied volatilities have been soaring. Therefore, option prices (premiums) reflect the high volatility in AMC shares.
In other words, company fundamental or even technical analysis may not necessarily justify these big moves in the shares. But options markets are currently providing opportunities that might be appropriate for bullish investors.
An option buyer would have to pay $17.65 X 100, or $1,765, in premiums to the option seller. This premium amount belongs to the option writer (seller) no matter what happens in the future, i.e. until or on the day of expiry. This put option will stop trading on Friday, Aug. 20, 2021.
Risk/Reward Profile For Unmonitored Cash-Secured Put Selling
Assuming a trader would now enter this cash-secured put option trade at $52.61, at expiration on Aug. 20, the maximum return for the seller would be $1,765, excluding trading commissions and costs.
The seller’s maximum gain is this premium amount if AMC stock closes above the strike price of $50.00. Should that happen, the option expires worthless.
If the put option is in the money (meaning the market price of AMC stock is lower than the strike price of $50.00) any time before or at expiration on Aug. 20, this put option can be assigned, and the seller would be obligated to buy 100 shares of AMC stock at the put option's strike price of $50.00 (i.e., at a total of $5,000).
The break-even point for our example is the strike price ($50.00) less the option premium received ($17.65), i.e., $32.35. This is the price at which the seller would start to incur a loss.
On a final note, the calculation of the maximum loss assumes the put seller was assigned the option and purchased 100 shares of AMC at the strike price of $50.00. Then, in theory the stock could fall to zero.
If the put seller gets assigned the option, the maximum risk is similar to that of stock ownership, but partially offset by the premium (of $1,765) received.
Cash-secured put selling is a moderately more conservative strategy than buying shares of a stock outright at the current market price. This strategy can be a way to capitalize on the wild swings in AMC stock with a measure of prudence.
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