Coca Cola Stock has been strong most of 2011 and certainly strong since the market pulled back in August 2011. I wrote an article recently about my Coca Cola Stock leap put trade of December 20 2011 which still brings up a lot of questions from readers. In this article I will try to explain my Coca Cola Stock leap put trade a bit more.
Here is the reader’s question on my Coca Cola Stock Leap Put Trade:
Thank you for your recent article on your Coca Cola Stock leap put trade. I was one of the readers that had asked why you sold the 2013 $55 leap put strike. Now I understand but I am still confused on one aspect of your strategy. If Coca Cola stock price was to decline below $55 in the next few months with most time value still available, what action would be appropriate? Assume that you still like the stock but it is the overall market that is falling and volatility has risen. Would you stay at the $55 strike? Would you roll down your Coca Cola Stock $55 leap puts and out to a later expiration (which might be too far at 2014)? When would you take such action? When Coca Cola stock price gets close to breaching $55 or would you wait some time to see what will happen before taking action. If you wait, do you not risk being in a position of not being able to roll or close at a profit since you will be too far ITM? I am successfully adopting some of you strategies but the roll still perplexes me. “
Coca Cola Stock Leap Put Trade Explained
The key to understanding my selling the $55 leap puts for 2013 in Coca Cola Stock is the chart below.
Recall in my article on the Coca Cola Stock leap put trade that I believe Coca Cola Stock is presently overvalued however I want to continue to sell puts in what I believe is a quality large cap stock. Select this Coca Cola Stock link to view investor relations at Coca Cola which may help you determine if this is a stock worthy of investing consideration.
The chart below shows Coca Cola Stock from 1995 to 2011. I have marked 3 put strike levels that I would own stock at; $55, $50 and $45.
If the stock falls lower than $55 before the end of 2012, I am not really interested in buying back my $55 strike puts. I would be more interested in selling additional puts at the strikes I have indicated above, namely either $50 or if there was a panic and the stock fell below $50, then definitely the $45.00.
It is important to understand that I have already earned $26,842.00 in income which will almost pay for all the 5 $55 strike put contracts if I should be assigned. Meanwhile I am continuing to sell puts in Coca Cola Stock, but I am closing them early to capture more income while waiting for the stock to pull back.
However I think a lot of readers fail to understand that I want to own the stock. I just don’t want to own it at today’s prices. If the stock should fall, I would rather put more capital into Coca Cola Stock by selling an equal number of put contracts at the $50 or $45 put strikes. If the stock should collapse and I am assigned at both the $45 and $55 strikes then my average cost would be $50.00. The present dividend is $1.88 which would give a yield of 3.76% at $50.00.
I think a lot of readers were confused because they are looking at the trade as NOT wanting the stock but just the income. If this was the case then I would not sell the Coca Cola Stock leap puts, but instead would continue with month to month put selling. In my case I want Coca Cola Stock.
Coca Cola Stock Leap Put Selling Theory
However in theory, investors who sell Coca Cola Stock leap puts at the $55 strike, who experienced a collapse in Coca Cola Stock prices, DO NOT need to hold onto their sold puts. They could easily buy to close the Jan 2013 $55 leap puts and roll lower, possibly out to April at the $50 put strike. This would result in a loss as the $55 put to buy to close would almost always cost more than the $50 would earn when sold.
However experienced investors who sell puts know that they could easily commit additional capital and average themselves lower by selling additional puts at lower strikes. By committing more capital and selling lower put strikes they would also earn additional income which would reduce or eliminate the loss from buying to close the Jan 2013 $55 puts early.
When To Roll Down Leap Puts
Another question readers asked me about the Coca Cola Stock leap put trade was when would I roll down the $55 leap put strikes. Again in theory, if by April 2012 Coca Cola Stock has fallen to $52.50, those investors not interested in owning Coca Cola Stock, could buy to close the Jan 2013 $55 strike and roll down to $52.50 in the same month (Jan 2013). When the April 2013 options are available, they could consider rolling to April 2013 at the $52.50 strike which would probably mean a very small loss from rolling from Jan $55 to April $52.50. I normally roll down when the put strike is breached to the next strike, which in Coca Cola Stock would be $52.50.
However it is important to understand the numerous strategies that are available for option sellers. If Coca Cola Stock was in a serious decline, the obvious choice for an option seller would be to sell naked calls. After all, you want the stock to recover. Therefore while rolling down the leap $55 put strike makes some sense, selling a couple of months out, out of the money naked calls, also makes a lot of sense to help reduce any loss from buying and rolling down the $55 leap put.
Final Word On Coca Cola Stock Leap Put Trade
The value of having a plan and the importance of strategy is paramount to successful investing, whether options, stock or both. My Coca Cola Stock leap put trade is in place and my plan is precise. If the stock falls I will not be buying back the $55 strike leap puts but looking forward to selling an equal number of put contracts at a lower strike to average myself into the stock. If the stock fell below $40.00 I would reassess and probably consider selling Coca Cola Stock in the money puts to guarantee myself some shares at a greatly reduced price. I hope this answers all the questions I have received on my Coca Cola Stock leap put trade. Remember, if as an investor you do not want the underlying stock when selling options, then I suggest not considering selling leap puts because any stock including Coca Cola Stock can surprise investors to the downside and a year when a stock is in trouble, can seem like an eternity.