Merck & Co. (NYSE:MRK) boasts a portfolio of blockbuster drugs, with Keytruda being a standout. Keytruda has secured approvals for various cancer treatments and has played a crucial role in driving Merck’s revenue growth. Other notable products in Merck’s portfolio include Simponi, Januvia, Janumet, Bridion, Isentress, ProQuad, Gardasil, Pneumovax 23, RotaTeq, and Belsomra. Merck stock has fallen by over 6% year-to-date but analysts are bullish on the stock for the future. You could buy Merck for a 5% discount, or achieve a 13% annual return, by trading cash secured puts.
Why Trade Cash Secured Puts?
Cash secured puts are a bullish strategy, albeit less bullish than outright stock ownership. Investors who have a positive outlook on a stock’s potential often prefer strategies like long calls or bull call spreads. Cash secured put sellers, on the other hand, employ this strategy when they anticipate that the stock will remain relatively stable, experience modest gains, or at the very least, not suffer substantial declines.
Cash secured put sellers allocate capital to buy the stock if assigned, demonstrating their willingness to take ownership. In contrast, naked put sellers aim solely to generate income through option premiums, with no intention of acquiring the stock.
The degree of bullishness among cash secured put investors determines the strike price’s proximity to the stock’s current price. Selling puts closer to the current price results in higher premiums and a greater likelihood of assignment. Conversely, selling deep out-of-the-money puts yields smaller premiums and a reduced probability of assignment.
Merck Stock Cash Secure Put Example
To illustrate this strategy, let’s examine a scenario involving Merck stock. Suppose MRK is currently trading at $103.94, and an investor decides to sell a November put option with a $100 strike price for approximately $1.78, earning a $178 premium. By selling the put, the investor commits to purchasing 100 MRK shares at $100 each if the option is exercised.
Even if MRK’s price were to decline to $99, $90, or even $60 by November 17, the put seller would still be obligated to buy 100 shares at $100 each. However, if MRK maintains a price above $100, the put option expires worthless, and the trader retains the $178 premium. The net capital at risk is the strike price of $100 minus the $1.78 premium, resulting in a net cost basis of $98.22. This represents a 5.41% discount compared to the stock’s previous trading price.
Should MRK remain above $100, the annualized return on capital is calculated as follows:
$178 / $9,822 = 1.81% over 50 days, which translates to an annualized return of 12.97%.
In summary, selling cash secured puts offers the potential for an annualized return of 12.97% or the opportunity to acquire a high-yield stock at a 5.41% discount, making it an attractive strategy for those seeking a favorable risk-reward profile.
While implementing cash secured put strategies demands substantial capital, it presents an opportunity to generate income from stocks you are willing to own. In the case of MRK, if assigned the shares, you can also benefit from its 2.77% dividend yield. Nevertheless, options trading carries risks, and investors could potentially lose their entire investment. Therefore, conducting thorough research and consulting with a financial advisor before making investment decisions is essential.
Bottom Line
In conclusion, selling cash secured puts presents an opportunity for income generation and acquiring stocks at a discount. Understanding the nuances of this strategy, coupled with diligent research, empowers investors to leverage its benefits while effectively managing associated risks. By exploring the strategy’s potential within the context of Merck, investors can discover how it aligns with their income and investment objectives.
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