This strategy should only be employed if you are bullish on the stock as there is a chance that the shares could be assigned to your account. The strategy not only provides you with the opportunity to leverage your position in Southern Company (NYSE:SO), but it also provides one with the chance to get into the stock at a much lower price. If you are not bullish on the long-term prospects of this stock, then, please do not put this strategy to use.
Suggested Strategy for Southern Company
This stock has had a very nice run so consider waiting at least for a test of the $45-$46 ranges before putting this idea into play. The stock is having a hard time breaking past $48 and there is a good chance that it will retest the $45-$46 ranges before breaking out.
This play has two parts to it. The first part entails selling a put and in the second part, calls are purchased with the proceeds from part 1.
The Jan 2013, 45 puts are trading in the $1.03-$1.07 ranges. If the stock pulls back to the stated ranges, these options should start to trade in the $1.40-$1.60 ranges. For this example, we will assume that each put can be sold for $1.45. For each contract sold $ 145 will be deposited in your account. The proceeds from the sale of these puts will be used to fund the purchase of the calls in Part 2.
The Jan 2013 50 calls are trading in the $0.40-$0.43 ranges. If the stock pulls back to the stated ranges, these calls should drop in price to the $0.20- $0.30 ranges. We will assume that if this comes to pass that the calls can be purchased for at $0.25 or better. For each put sold you will be able to purchase up to five calls and still have a net credit of $25.
Benefits of this strategy
This strategy provides you with the opportunity to significantly leverage your position in this stock for almost free. Hardly, anyone is fully invested in the markets all the time and so the money sitting in your account is dead money. If you are bullish on the stock this would be a good way to significantly boost your rate of return for little to no cost. If the other hand you were going to use this money on another play and decided instead to use it on this play, then it would make sense to count the money that is used to secure the puts as part of your cost. With this strategy, you have the ability to control 500 shares for each put you sell. Thus, you can significantly leverage your position with little to no cost. If you had to purchase 500 shares at the current price, your cost would be in excess of $23K.
If the stock trades below the strike price, you sold the puts at, the shares could be assigned to your account. Depending on the number of calls you purchased your cost per share could range from $43.80 (if you purchased one call only) to $44.75 (if you purchased five calls).
If you put this strategy to use just because you were enticed with the gains, then you could be taking on quite a bit of risk, as the stock could trade well below the strike price, and the shares could be put into your account.
If, on the other hand, you were bullish on this stock and were ready to purchase it, then this strategy provides you with a way to get into the stock at a lower price and also provides you with the option of significantly leveraging your position. If the stock takes off, you could walk away with some pretty decent gains. The leverage part of this trade is free as you are paying for it with the proceeds from the sale of the puts.
Only investors who are bullish on this stock should put this strategy into play, as there is a chance that the shares could be assigned to your account if the stock trades below the strike price. Consider taking profits if the calls show gains in the 70%-100% ranges. You would do this by selling the calls and buying back the puts. Investors looking for other ideas might find this article to be of interest - Morgan Stanley: In At $11.38 Or Walk Away With an extra 12.4% in 7 months.
EPS and Price vs industry charts obtained from zacks.com. A major portion of the historical data used in this article was obtained from zacks.com. Options tables sourced from yahoofinance.com. Earnings and growth data sourced from dailyfiance.com.
It is imperative that you do your due diligence and then determine if the above strategy meets with your risk tolerance levels. The Latin maxim caveat emptor applies - let the buyer beware.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.