Living On The Edge: Selling Puts On 5 Stocks

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 |  Includes: AMSC, AONEQ, ARNA, LEU, SVNTQ
by: The Financial Lexicon

In today’s electronically advanced, computer driven financial markets, there seem to be endless possibilities for investors of all shapes and sizes. While some investors would never dream of dabbling in the world of options, others use options in a variety of ways and for a variety of purposes when it comes to portfolio management. In “Catch These Falling Knives By Selling Puts,” I offer ideas for selling puts on six different companies whose stocks have gotten crushed this year. Strategically selected strike prices were chosen for December and January expirations, with approximately 10% to 45% of downside protection before an assignment becomes likely.

For those options investors looking to take on more risk, with the possibility of higher rewards, here are a few ideas. These stocks take the meaning of risk to a whole new level. None of these companies currently has positive earnings per share, and significant declines from present levels cannot be ruled out. Each of these stocks is currently trading under $5 per share. With those lower stock prices often comes higher option premiums, and these are no exception.

While taking this type of risk is generally not my cup of tea, I don’t want to discriminate against those investors who search for precisely these types of ideas. If you are such an investor, then without further ado, in no particular order, they are:

Arena Pharmaceuticals (NASDAQ:ARNA) has generally been consolidating in the $1.20 to $2 range for well over a year. For a short period of time, it did manage to trade above $2, but those days ended in the early part of this year. On the lower end of the range, the stock has found support in the $1.20s on multiple occasions over the past year. The company’s investigational drug, Lorcaserin, is due to be resubmitted to the FDA for approval at some point in the near future, and no FDA decision is likely before January option expiration.

If the company fails to resubmit the new drug application as promised by the end of 2011, all bets are off on where this stock could go. Currently, the $1 January 2012 puts are bidding 10 cents. ARNA is currently trading at $1.34. If the stock closes no lower than 25.3% below where it currently trades, the puts will expire worthless. In a cash account, should these puts expire worthless, this trade will yield 10% in two months, a 60% annualized gain.

USEC (USU), the low enriched uranium supplier, broke below its bear market lows of 2008 a few months back before bottoming at $1.17 in early October. It then rallied over 100% during the October stock market swoon before falling back. It currently sits at $1.30. Like ARNA, the January 2012 $1 puts are currently bidding 10 cents. If the stock closes no lower than 23% below where it currently trades, the puts will expire worthless. In a cash account, should these puts expire worthless, this trade will yield 10% in two months, a 60% annualized gain.

Savient Pharmaceuticals (SVNT), the biopharmaceutical company that develops KRYSTEXXA and sells branded and generic versions of Oxandrin, recently broke its bear market lows of 2008. During the past decade, the stock has found support in the $1.80 to $2 range on a couple of occasions and could well be on its way there again. Currently, the December 2011 $2 puts are bidding 8 cents with less than four weeks to expiration. SVNT is currently trading at $2.52. If the stock closes no lower than 20.6% below where it currently trades, the puts will expire worthless. In a cash account, should these puts expire worthless, this trade will yield 4% in roughly four weeks, a 52% annualized gain.

A123 Systems (AONE) is a manufacturer of rechargeable lithium-ion batteries. AONE has been in a fairly well-defined downtrend since its all-time high set on October 5, 2009, shortly after its IPO. There is no previous support level to speak of for this stock. Although, when looking at the $3 December 2011 puts asking 95 cents, along with the fact that there are still bids showing up on the $3 calls, there are some investors who think this stock can hold above $2 through December expiration.

Currently, the December 2011 $2 puts are bidding 15 cents with less than four weeks to expiration. With AONE currently trading at $2.25, if the stock closes no lower than 11.1% below where it currently trades, the puts will expire worthless. In a cash account, should these puts expire worthless, this trade will yield 7.5% in roughly four weeks, a 97.5% annualized gain.

American Superconductor Corporation (NASDAQ:AMSC), the renewable energy company focused on wind power, has seen its stock absolutely plummet in the past year, from a high of $34.53 to a low of $3.21 on October 4. Surprisingly enough, October 4 also marked the date of another bottom for this stock, the bottom from the 2000 to 2002 bear market. At that time, the stock traded as low as $2.0975, although it spent relatively little time under $3. Beginning in late October 2002, AMSC spent several months consolidating, generally in the $3 to $4 range, before moving higher.

Currently, the December 2011 $3 puts have an implied volatility of 1.16 and a theoretical price of 9.3 cents. If the market offers an opportunity to sell those puts for 10 cents with the stock trading roughly where it is today, that would be the entry point. AMSC is currently trading at $4.03. If the stock closes no lower than 25.5% below where it currently trades, the puts will expire worthless. In a cash account, should these puts expire worthless, this trade will yield 3.33% in roughly four weeks, a 40% annualized gain.

If you decide to enter a position on any of these companies, please have an exit strategy in case things don’t go as you planned. None of these companies currently have positive earnings per share, and given the potential for a liquidity crunch out of Europe affecting markets world-wide, exit plans are of the utmost importance for today’s options traders.

Caveat Emptor! Or, in this case, “Let the seller beware.”

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.