How to Buy IBM at a 6% Discount or Collect A 36.7% Return (Annualized) in Just 3 Days

A cash-secured put, or naked put is an income-generating strategy that traders use to generate income by selling naked put options. With this bullish strategy, investors bet the underlying stock will remain stable or trade above the put option’s strike price at expiration. Profit is limited to the premium, or income received. The risk in selling put options is that should the security trade less than the options strike price, the paper loss is the difference between the options strike price and the underlying’s price at expiration.  However, the premium received helps minimize the loss. The naked put strategy is successful when the underlying security trades above the put options’ strike price at expiration.
 

With regards to a put option trade, there are two possible outcomes.  
 

Outcome 1: The underlying stock trades below the strike price at expiration and put option expires “in-the-money”, and the put seller buys 100 shares of the underlying stock (in this case, IBM), an agreed-upon price (the strike price) - at any point up to and including the expiration date.  The investor keeps the premium.  And, at that point, the investor can hold the stock for dividends, sell covered calls on the stock, or sell it at the current market price.
 

Outcome 2: The underlying stock trades at or above the strike price at expiration, and the put option expires “at-the-money”, or “out-of-the-money”. In other words, the option expires worthless and the option seller gets to keep the option premium. At that point, the option seller can repeat the process. 
 

This weeks’ trade idea considers selling a cash-secured put option on IBM stock.

Headquartered in Armonk, New York, IBM is an information technology (IT) company. The company operates in five segments: Global Technology Services, Global Business Services, Software, Systems and Technology, and Global Financing. The Global Technology Services segment provides IT infrastructure services and business process services. The Global Business Services segment offers professional services and application management services. The Software segment consists primarily of middleware and operating systems software. The Systems and Technology segment provides computing power and storage solutions; and semiconductor technology products and packaging solutions. The Global Financing segment invests in financing assets, leverages with debt, and manages the associated risks.

The company is also a dividend aristocrat newcomer, a company that is listed on the S&P 500 index, and has increased its dividend for at least each of the past 25 years. In fact, IBM has an impressive streak of dividend increase streaks in the industry, with over 26 years of increased dividends. And in the last 5 years, IBM has grown the dividend, on average, 30.2% a year.

IBM offers an impressive current dividend yield of 5.07% and its stocks are trading at about 10% higher than just 1 year ago. And, thanks to sound business fundamentals, the company’s dividend yield has increased 30.2% for each of the past 5 years.

IBM’s options volatility IV is currently 29.87% (Implied volatility) is off its 52-week highs of 44.53% recorded yesterday, on 1/24/22.  That, coupled with the bearish market sentiment thanks to the impending interest rate hikes, and geopolitical issues with Russia, could make it a good candidate for selling a put option to generate income in a week as investors may realize an annualized return of 36.7% in 3 days or less, or purchase a solid company, with a stable dividend. 

Analyst Rating

Barchart analysts have a 52-week target price on IBM between $124.00 at the low end and $170.00 a share at the high end.  The $148.11 mean target price is slightly higher than the current trading price of $132.18.  This is in line with IBM 52 week range between $114.56 and $152.84.

While the Barchart Ratings are mixed across the board, long-term indicators seem to support a continuation of the upward trend.

IBM $123 Put Option Expiring 2022-01-28

Investors can consider selling an IBM $123 put option expiring 01-28-2022.  There is no earning call risk as the latest earning date was 01-24-2022. For this trade, the investor would sell 1 put option with a limit price of $0.40 (option premium).  At print time, $0.40 was the mid-point between the bid and ask. 

The annualized rate of return on this option is 36.7%. You can calculate the annualized rate of return on this trade, in the following way: $0.40/$132.52/3*365

Furthermore, there is an approximate 89.92% chance of the option expiring worthless.  And historically, anything over 75% is above average.  

Should the option be exercised, investors will buy 100 shares of IBM for every put option contract sold, for $123/share - about a 6% reduction from today’s trading price.  Should that happen, and as part of a wheel strategy, investors can sell covered calls on their stocks, until such time their stocks are called away.

Mitigating Risk

Risk-averse investors who are not interested in acquiring the shares may consider one of two options.  

1. Investors can mitigate risk by setting up a GTC (Good-Until-Cancelled) stop loss at around 50% of the option premium.  This way, should the stock trade around the strike price before expiration, the investor can “Buy-to-close” their trade to prevent buying the stock should it trade less than the strike price. Alternatively, the investor can “roll” the option by buying back the option at the current price, and then selling another put option further down the road.

*Disclaimer: On the date of publication, Rick Orford did not have (either directly or indirectly) any positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. Data as of January 25, 2022.