Heavyweight agricultural commodities shareholders Archer-Daniels-Midland (NYSE:) have delivered strong returns so far in 2021. ADM shares are up about 17% this year, reaching a record high in early June . But since then, the stock has lost about 14% of its value.
The 52-week range of ADM stock was $43.64-$69.30. The current price of $59.4 at the time of writing supports a 2.5% dividend yield.
Despite the recent fall in prices, Wall Street is still optimistic about the company in the long term. According to 15 analysts surveyed by Investing.com, the average 12-month price forecast is $67.54, implying a return of about 13.5%.
Chart: Investing.com
So today we look at how bullish investors might consider selling cash-backed put options on AMD stock. Such a transaction could be especially attractive to those looking to receive premiums (from put sales) or potentially own Archer-Daniels-Midland stock for less than their current market price of $59.40.
We previously discussed the detailed mechanics of cash-backed puts sales using Exxon Mobil stock. Readers new to selling should consider reading that article.
How Q2 Earnings Have Beed Leading Oilseed and Agricultural Commodity Processor. It also has an extensive global network to store and transport crops. The end products include vegetable oil, corn sweeteners, animal feed ingredients, flour and vegetable industrial oils.
The group announced a robust second quarter at the end of July. Revenue came in at $22.92 billion. A year ago, that was $16.28 billion. Adjusted net income of $754 million translated into adjusted earnings per share of $1.33. Last year that statistic was 85 cents.
The agribusiness giant reports revenues in three main segments:
Ag Services and Oilseeds – operating profit up about 38% YoY;
Carbohydrate Solutions – operating profit up approximately 96% year-over-year;
Nutrition – operating profit up approximately 96% year-over-year.
About the results, CEO Juan Luciano said:
“It was another excellent quarter for ADM as our team posted record profits, with strong year-over-year earnings growth in all three business units.”
Trailing P/E ratio for ADM stock is 12.32x. The shares are also trading at 0.44x sales. In other words, despite the recent price increase, the valuation level is not overloaded.
Given the strong fundamentals, many investors believe that ADM stocks are likely to hit new highs in the coming months. However, there may still be short-term volatility in the share price.
Selling cash puts on ADM shares
time frame extending to the option's expiration date. They generally want one of two things. In other words:
Generate income (via the premium received from the sale of the well); or
Owning a certain stock despite finding the current market price per share (i.e. $59.40 for ADM now) higher than what they would be willing to pay.
A put option contract on Archer-Daniels-Midland stocks is the option to sell 100 shares. Cash-secured means that the investor has enough money in their trading account to buy the security if the stock price falls and the option is granted. This cash reserve must remain in the account until the option position is closed, expires, or the option is assigned, meaning ownership has been transferred.
Let's assume an investor wants to buy ADM stock, but does not want to pay the full price of $59.40 per share. Instead, the investor would prefer to buy the shares at a discount in the coming months.
One possibility would be to wait for the Archer-Daniels-Midland stock to drop, which may or may not happen. The other option is to sell one contract of a cash-backed ADM put option.
So the trader would typically write an at-the-money (ATM) or an out-of-the-money (OTM) ADM put option while simultaneously setting aside enough cash to buy 100 shares of the stock.
Let's assume that the trader puts in this trade until the option's expiration date of December 17. Since the stock is currently $59.40 at the time of writing, an OTM put option would have a 55.00 strike. Thus, the seller would have to buy 100 shares of Archer-Daniels-Midland on the strike for $55.00 if the buyer of the option were to exercise the option to allocate it to the seller.
The ADM December 17, 2021, 55-strike put option is currently offered at a price (or premium) of $1.45.
An option buyer would have to pay $1.45 X 100, or $145, in premium to the option seller. This premium amount belongs to the option seller, no matter what happens in the future. This put option will stop trading on Friday, December 17.
Risk/reward profile for unmonitored cash-secured put sales
Assuming a trader would use this cash Enter- secure trading put options for $59.40, upon expiration on December 17, the maximum return for the seller would be $145, excluding trading commissions and fees.
The seller's max profit is this premium amount if ADM shares close above the $55.00 strike price. If that happens, the option will expire worthless.
If the put option is 'in the money' (meaning that the market price of Archer-Daniels-Midland shares is less than the strike price of $50.00) before or upon expiration on December 17, this put option can be assigned. The seller would then be required to purchase 100 shares of ADM stock at the put option's strike price of $55.00 (i.e. $5,500 in total).
The breakeven point for our example is the strike price ($55.00) minus the option premium received ($1.45), i.e. $53.55. This is the price at which the seller would lose money.
Finally, the maximum loss calculation assumes that the put seller obtained the option and purchased 100 shares of Archer-Daniels-Midland at the strike price of $55.00. Then the stock could theoretically fall to zero.
If the put seller is assigned the option, the maximum risk is similar to that of stock ownership, but partially offset by the premium received (of $145).
Bottom Line
Cash-secured put selling is a fairly more conservative strategy than buying a company's stock at the current market price. This strategy could be one way to capitalize on the jerkiness in ADM stocks in the coming weeks.
Investors who end up owning Archer-Daniels-Midland shares as a result of selling puts may further consider setting up covered calls to increase the potential return on their shares. In other words, selling cash-backed puts can be considered the first step in owning stock.
