Agree To Buy Advance Auto Parts At $75, Earn 7.3% Using Options
Stock Options Channel Staff - Wednesday, March 7, 11:59 AMInvestors considering a purchase of Advance Auto Parts Inc (AAP) shares, but tentative about paying the going market price of $117.99/share, might benefit from considering selling puts among the alternative strategies at their disposal. One interesting put contract in particular, is the January 2020 put at the $75 strike, which has a bid at the time of this writing of $5.50. Collecting that bid as the premium represents a 7.3% return against the $75 commitment, or a 3.9% annualized rate of return (at Stock Options Channel we call this the YieldBoost).
Selling a put does not give an investor access to AAP's upside potential the way owning shares would, because the put seller only ends up owning shares in the scenario where the contract is exercised. And the person on the other side of the contract would only benefit from exercising at the $75 strike if doing so produced a better outcome than selling at the going market price. (Do options carry counterparty risk? This and six other common options myths debunked). So unless Advance Auto Parts Inc sees its shares fall 36.5% and the contract is exercised (resulting in a cost basis of $69.50 per share before broker commissions, subtracting the $5.50 from $75), the only upside to the put seller is from collecting that premium for the 3.9% annualized rate of return.
Worth considering, is that the annualized 3.9% figure actually exceeds the 0.2% annualized dividend paid by Advance Auto Parts Inc by 3.7%, based on the current share price of $117.99. And yet, if an investor was to buy the stock at the going market price in order to collect the dividend, there is greater downside because the stock would have to lose 36.45% to reach the $75 strike price.
Always important when discussing dividends is the fact that, in general, dividend amounts are not always predictable and tend to follow the ups and downs of profitability at each company. In the case of Advance Auto Parts Inc, looking at the dividend history chart for AAP below can help in judging whether the most recent dividend is likely to continue, and in turn whether it is a reasonable expectation to expect a 0.2% annualized dividend yield.
Below is a chart showing the trailing twelve month trading history for Advance Auto Parts Inc, and highlighting in green where the $75 strike is located relative to that history:
The chart above, and the stock's historical volatility, can be a helpful guide in combination with fundamental analysis to judge whether selling the January 2020 put at the $75 strike for the 3.9% annualized rate of return represents good reward for the risks. We calculate the trailing twelve month volatility for Advance Auto Parts Inc (considering the last 252 trading day closing values as well as today's price of $117.99) to be 43%. For other put options contract ideas at the various different available expirations, visit the AAP Stock Options page of StockOptionsChannel.com.
In mid-afternoon trading on Wednesday, the put volume among S&P 500 components was 1.23M contracts, with call volume at 1.23M, for a put:call ratio of 0.70 so far for the day, which is above normal compared to the long-term median put:call ratio of .65. In other words, if we look at the number of call buyers and then use the long-term median to project the number of put buyers we'd expect to see, we're actually seeing more put buyers than expected out there in options trading so far today.
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