This Under $3 Stock Could Yield 14.3% in Less than 40 Days

The commercials were definitely the highlight of the 2014 Super Bowl, as the action on the field was no contest. RadioShack (NYSE: RSH) embraced its stodgy, out-of-fashion image with a self-effacing ad about how the consumer electronics retailer was stuck in the 1980s.

As for its stock, RSH has been stuck in a severe downtrend since 2010, dropping from highs near $24 to a low just above $2.

[ad#Google Adsense 336×280-IA]However, while the July lows were eclipsed on the downside by the January decline, volatility did not make new highs.

A bullish divergence like this is often a sign of price stability and a base forming, and the stock has rebounded almost 25% from the lows made less than a month ago.

RSH has traded in a channel from $4 to $2 since mid-2012.

An upside breakout of the range targets a move to $6.

Buying at such discounted prices is attractive to traders wishing to position themselves for a long-term recovery in the stock.

If you are comfortable holding on to this inexpensive stock for a potential recovery, then selling puts could allow you to collect income while you wait to get into RSH at a 30% discount.

Cash-Secured Put Selling Strategy

While the typical investor might use a limit order to buy a stock or ETF at a designated price or lower, the options trader can do one better by selling a cash-secured put option.

This strategy has the same mathematical risk profile as a covered call. When selling puts, there is an obligation to buy the stock at the option’s strike price if it is assigned, allowing you to get into the stock at a discount. In fact, the true entry cost basis is even lower with the subtraction of the premium you earned from selling the puts.

And if the stock is not below the strike price at expiration, then the premium received is all profit. In other words, you’re getting paid not to own the stock.

There are two rules traders must follow to be successful at selling puts.

Rule One: Only sell put options on stocks you want to own.

The intention of the put selling strategy is to be assigned the stock as a long-term investment. Each option contract represents 100 shares, so make sure you have the funds in your account to buy the stock at the option’s strike price if a sell-off occurs. Paying in full ensures that no additional money is needed to hold the stock for potentially many months or even years until a price recovery.

Rule Two: Sell either of the front two option expiration months to take advantage of time decay.

Collect premium each month from selling puts until you are assigned shares at a cost-reduced basis. Every month that you keep the premium is money subtracted from your entry price.

Recommended Trade Setup: Sell to open RSH March 2 Puts at $0.25 or better. (Use a limit order to get the desired level of income.)

This cash-secured put sale would assign long shares at $1.75 ($2 strike minus $0.25 premium), which is about 30% below RSH’s current price, costing you $175 per option sold. If the put option expires worthless, you keep the $25 premium, earning a potential 14.3% return in 39 days.

Remember, you should only sell this put option if you want to own RSH at a discount to the current price.

If you are assigned the shares, an April covered call can be sold against the stock to lower your cost basis even further. If RSH does not fall below the strike price before expiration, then you keep the premium you collected, essentially getting paid not to buy the stock.

— Alan Knuckman

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Source: ProfitableTrading