We recently introduced two exchange-traded funds (ETFs) that could be suitable for investing in one of the most followed meme stocks, cinema operator AMC Entertainment (NYSE:) . Since the beginning of the year, AMC's shares have risen about 2,400%, fueled by the enthusiasm of private investors.
In the first months of the pandemic in 2020, the shares had collapsed. Still, the stock's fortunes began to change when it caught the attention of traders on social media platforms such as Reddit and Twitter. Earlier in 2021, AMC stock rose during a short squeeze. The stock price exploded in a matter of weeks. The 52-week range was $1.91-$72.62.
Today we look at AMC stock to see how investors might consider selling cash-backed put options on the company. Such a trade could be especially attractive to those looking to receive premiums (from put sales) or who may wish to own AMC stock for less than the current market price of $52.61, as we write Tuesday.
We have previously discussed the operation of cash-backed puts sales using shares of ExxonMobil (NYSE :). Readers new to selling may want to consider perusing that article.
Selling cash puts on AMC stock
Investors writing cash-backed puts are typically optimistic about a stock during the time frame extending to the option's expiration date. They generally want one of two things. Either to:
1. Generate income (via the premium received by selling the put), or
2. Own a certain stock but find the current market price per share (i.e. $52.61 for AMC now) higher than what they would be willing to pay.
One put option contract on AMC stock is the option to sell 100 shares. Cash-secured means that the investor has enough money in the brokerage account to buy the security if the price of the stock 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 that an investor wants to buy AMC stock, but does not want to pay the full price of $52.61 per share. Instead, the investor would prefer to buy the stock at a discount over the next six to ten weeks.
One option is to wait for AMC stocks to fall, which may or may not be possible. The other option is to sell one contract of an AMC cash-backed put option.
As a result, the put seller would assume the obligation to buy potentially 100 shares of AMC at a certain price (the strike price) at maturity, and now be paid a certain amount of premium for entering into that obligation .
So the trader would typically write an at-the-money (ATM) or out-of-the-money (OTM) AMC put option while simultaneously setting aside enough cash to buy 100 shares of AMC stock.
Let's assume the trader executes this trade until the option's expiration date of August 20. Since AMC stock is currently $52.61, an OTM put option would have a strike of 50. The seller would have to buy 100 shares of AMC for $50.00 if the buyer of the option were to exercise the option to allocate it to the seller.
The AMC August 20, 2021, 50.00 strike put option is currently offered at a hefty price (or premium) of $17.65.
Readers following the options markets would have noted that the realized and implied volatilities of AMC stock have soared. Therefore, option prices (premiums) reflect the high volatility in AMC stock.
In other words, the company's fundamental or even technical analysis doesn't necessarily justify these big moves in the stock. But options markets currently offer opportunities that may be suitable for bullish investors.
An option buyer would have to pay $17.65 X 100, or $1,765, in premium to the option seller. This premium amount belongs to the option writer (seller) whatever happens in the future, i.e. until or on the day of expiration. This put option will stop trading on Friday, August 20, 2021.
Risk/Reward Profile for Unverified Cash Put Sell
Assuming a trader would now enter this cash backed put trade at $ 52.61, at expiration on August 20, the maximum return for the seller would be $1,765, excluding trading commissions and fees.
The seller's max profit is this premium amount if AMC shares close above the $50.00 strike price. If that happens, the option will expire worthless.
If the put option is in the money (meaning the market price of AMC stock is less than the $50.00 strike price) anytime before or upon expiration on August 20, this put option can be assigned, and the seller would be required to purchase 100 shares of AMC stock at the put option's strike price of $50.00 (ie $5,000 in total).
The breakeven point for our example is the strike price ($50.00) minus the option premium received ($17.65), i.e. $32.35. 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 AMC at the strike price of $50.00. 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 $1,765).
Bottom Line
Cash-secured put selling is a fairly more conservative strategy than buying shares of a stock at the current market price. This strategy could be a way to profit with some caution from the wild swings in AMC stocks.
