Option Strategy for Talbots (TLB)

10/27/2009 12:01 am EST

Focus: OPTIONS

Bullish on retail? The last quarter of the year is typically the best one for this sector. In fact, some retailers count on the final two to three months of the year for 40% of their annual sales. This cash-secured put on Talbots (TLB) currently has an attractive yield and may be an appealing trade for those of you who like the retail group and look for limited risk.

This cash-secured put strategy allows time decay to be the investor’s ally. As expiration approaches over the next two months, the put will lose time value. If and when it expires worthless, the premium collected is retained as profit. Alternatively, if the put moves in the money and is exercised, the investor can buy the stock at an effective discount.

TLB Cash-Secured Put Trade Details

TLB shares are trading at $10.45 (at the time of this writing)

Cash-Secured Put

  • Sell the TLB December 10 put (out-of-the-money) for $1.15 per contract
  • Net credit of $1.15 ($115)
  • For every contract, set aside $885 in cash: [(10-1.15) * 100]

Securing the sold put with cash means the capital is available to buy the shares if assigned. At this point, you’ll have purchased TLB shares at an effective price of $8.85, or 15.3% less than they are currently priced.

Find retail sales economic announcements with the MoneyShow.com/Econoday Economic Calendar

Profit/Loss Details

The maximum potential profit for this strategy is the premium collected, or $1.15 per contract—minus any commissions paid at the time of the trade’s execution. Remember, a cash-secured put that expires worthless will not require any commissions to “exit” the trade.

The maximum risk for this position is $8.85, or the strike price minus the premium collected. Theoretically, this risk is in playif the investor is forced to buy the stock and if TLB shares were then to decline all the way to zero. With this and all other cash-secured put strategies, the break even is also the strike price minus the premium collected, or $8.85 in this trade. TLB would need to drop the aforementioned 15.3% to breach this break-even point. Return on risk for this strategy is almost 13%.

By the staff at ONN.tv

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