As investors and traders, there's one thing we can never get enough of: hearing about strategies that can make us a lot of money.
You may have recently heard about one of our Platinum members, Dr. Kane, netting over $1 million with put credit spreads.
Using the core principles behind Dr. Kane's strategy, I found several awesome trades from our system, and I narrowed them down to the filet mignon of the bunch.
Before I reveal what I uncovered, I have something very important to share…
This Trade Is an Example ONLY
I want to make one thing clear before we begin.
Like stocks, options prices can and will change. Between the time of writing this piece and the time you read it, I can almost guarantee prices will be different.
Even if I wrote it an hour before you read it, prices would likely be different.
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That's why screeners are a critical tool for options strategies, especially when you look for contracts that expire within one to two weeks.
So, please know this trade is intended to be an example ONLY.
It is meant to demonstrate and educate.
It is NOT meant to be a trade you try to actually make right now.
With that in mind, let's take a look at the example…
Putting Nucor to the Test
Nucor Corp. (NUE) is a steel manufacturer based out of North Carolina.
I like this stock because as a commodity producer, it's benefiting from the inflation theme we're witnessing across the market. In addition, Nucor has already reported its first quarter earnings, which beat analysts' expectations.
Let's take a brief look at the weekly chart.
Source: TradeSmith Finance
From this chart, there are a few items I want to bring to your attention. First, along the bottom, you'll see that the Health Indicator is now green. Previously, it was yellow between September 2021 and November 2021.
This qualifies the stock for TradeSmith's Low Risk Runners strategy.
A stock in the Yellow Zone still operates within the normal range of volatility. However, since it's fallen off from its highs, it carries half the risk as a stock that's in the Green Zone.
So, by selecting a stock that recently returned to the Green Zone, we hit that sweet spot where shares are in an uptrend and carry less downside risk.
You'll also notice a green circle with an "E" in it, as well as a red one below it with an "I".
"E" identifies a spot where our system signaled an entry, and the red line indicates the stop loss.
What I want you to see is how close shares came to that stop loss in the Yellow Zone.
This is another indication of what our system sees as limited downside risk based on our entry and stop loss signals.
One of the criteria you won't see on this chart is the price-to-earnings (P/E) ratio, but it's still an important data point to factor into our analysis.
As I write this, Nucor carries a P/E ratio of 6.68x. That means the company could pay for all its stock in 6.68 years (assuming that it were possible to pay with profits).
This criteria helps to select companies with cheap valuations to keep our downside limited.
First, our system selected the $146 put for Nucor (NUE) that expires on May 6, 2022.
For the examples below, I want to emphasize that all figures are based on data that was current at the time of writing.
With that in mind, this option traded at $1.12. Since each option contract controls 100 shares of stock, that equates to a maximum profit of $112.
Nucor's share price at the time of writing is $160.65.
If I simply sold the put option without creating a spread, here are the nuts and bolts:
I would receive a $1.12 credit for each option contract I sold, or $112 in total.
My maximum profit of $112 would occur at expiration as long as Nucor finishes at or above $146.
My breakeven price would be $146 minus the $1.12 credit I received, or $144.88.
As long as the stock finishes above $144.88 by expiration, I will make money.
If the stock closes anywhere below $144.88, I lose $1 for every $0.01 per contract.
To initiate this trade, I would need to set aside $14,488 of buying power for a cash-secured put or $1,964.80 if I used margin.
Now, our system calculates that the probability of this trade achieving maximum profit is 79%.
That means I have a 79% chance at the contract expiring worthless and keeping my full premium. But it leaves me with a 21% chance of losing money. For some, that risk is still a little too high in today's market.
Like many investors, Dr. Kane is not comfortable selling naked puts. That's why he developed his strategy...
So you can create a put credit spread on Nucor by buying another put option below $146 with the same expiration.
For example, here is the latest price for the $144 strike for Nucor with the same May 6 expiration.
Source: TradeSmith Finance
The current price listed for the May 6, 2022, $144 put on Nucor is $0.94, or $94 per contract.
If I added this to my trade, I would create a put credit spread that works as follows:
I would sell the $146 strike put for $1.12 and buy the $144 strike put for $0.94, giving me a net credit of $0.18, or $18 per spread.
The $18 maximum profit would occur at expiration as long as shares of Nucor closed at or above $146.
My breakeven price would be $146 minus the $0.18 credit, or $145.82.
My maximum possible loss is the difference between the two strike prices minus the credit I receive to initiate the trade: $146 - $144 - $0.18 = $1.82, or $182 per option spread.
Maximum possible loss occurs at expiration if the price of Nucor is at or below $144.
You can increase the credit you receive for the put credit spread by lowering the strike price of the lower put option. However, your risk will increase, as will your maximum potential loss.
The cool part about option spreads is that you have to set aside much less cash to cover your maximum potential loss than you would for a cash-secured put alone.
While $18 on its own isn't going to put you into early retirement, it's a nearly 10% return on the much more palatable amount at risk, and you can accomplish that gain in less than a week – only five days. That's an annualized gain of 520% - and it's the secret to Dr. Kane's millionaire-making success.
Remember, this was simply a demonstration, but it's why I believe software like this is critical to help you find real-time opportunities so that you can be as successful as Dr. Kane, hauling in millions of dollars.
Enjoy your Monday,
Keith Kaplan CEO, TradeSmith
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Best of TradeSmith
The chart below represents the best-performing open positions over the last two years, as recommended by our software.
TradeSmith is not registered as an investment adviser and operates under the publishers' exemption of the Investment Advisers Act of 1940. The investments and strategies discussed in TradeSmith's content do not constitute personalized investment advice. Any trading or investment decisions you take are in reliance on your own analysis and judgment and not in reliance on TradeSmith. There are risks inherent in investing and past investment performance is not indicative of future results.
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