Bullish Archer Daniels Midland? Cash-Secured Puts Could Lower Price, Earn Income

Chart: Investing.com

So today, we look at how bullish investors might consider selling cash-secured put options on AMD stock. Such a trade could especially appeal to those who want to receive premiums (from put selling) or to possibly own Archer-Daniels-Midland shares for less than their current market price of $59.40.

We previously discussed the detailed mechanics of cash-secured put selling using Exxon Mobil stock. Readers who are new to put selling may want to consider reviewing that article.

Chicago-based Archer-Daniels-Midland is a leading processor of oilseeds and agricultural commodities. It also has an extensive global network to store and transport crops. Its end products include vegetable oil, corn sweeteners, feed ingredients, flour and plant-based industrial oils.

The group announced robust Q2 metrics at the end of July. Revenue came in at $22.92 billion. A year ago, it had been $16.28 billion. Adjusted net earnings of $754 million translated into adjusted EPS of $1.33. Last year, that metric was 85 cents.

The agribusiness giant reports revenue in three main segments:

• Ag Services and Oilseeds – operating profit up about 38% year-over-year (YoY);
• Carbohydrate Solutions – operating profit up about 96% YoY;
• Nutrition – operating profit up about 96% YoY.

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On the results, CEO Juan Luciano said:

“It was yet another excellent quarter for ADM, as our team delivered record earnings, with strong year-over-year profit growth across all three business units.”

Trailing P/E ratio for ADM shares stands at 12.32x. The shares are also trading at 0.44x sales. In other words, despite the recent run-up in price, the valuation level is not overstretched.

Given the strong fundamentals, many investors believe ADM stock is likely to see new highs in the coming months. However, there could still be short-term volatility in the share price.

Investors who write cash-secured puts are typically bullish on a stock during the timeframe that extends to the option expiry date. They generally want one of two things. Either to:

• Generate income (through the premium received by selling the put); or
• Own a particular stock, in spite of finding the current market price per share (i.e., $59.40 for ADM now) higher than what they would like to pay.

A put option contract on Archer-Daniels-Midland stock is the option to sell 100 shares. Cash-secured means the investor has enough money in their brokerage account to purchase the security if the stock price falls and the option is assigned. This cash reserve must remain in the account until the option position is closed, expires, or the option is assigned, which means 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 buying the shares at a discount within the next several months.

One possibility would be to wait for Archer-Daniels-Midland stock to fall, which it might or might not do. The other possibility is to sell one contract of a cash-secured ADM put option.

So the trader would typically write an at-the-money (ATM) or an out-of-the-money (OTM) ADM put option and simultaneously set aside enough cash to buy 100 shares of the stock.

Let's assume the trader is putting in this trade until the option expiry date of Dec. 17. As the stock is currently $59.40 at time of writing, an OTM put option would have a strike of 55.00. So the seller would have to buy 100 shares of Archer-Daniels-Midland at the strike at $55.00 if the option buyer were to exercise the option to assign it to the seller.

The ADM Dec. 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, Dec. 17.

Assuming a trader would enter this cash-secured put option trade at $59.40, at expiration on Dec. 17, the maximum return for the seller would be $145, excluding trading commissions and costs.

The seller's maximum gain is this premium amount if ADM stock closes above the strike price of $55.00. Should that happen, the option expires worthless.

If the put option is in the money (meaning the market price of Archer-Daniels-Midland stock is lower than the strike price of $50.00) any time before or at expiration on Dec. 17, this put option can be assigned. The seller would then be obligated to buy 100 shares of ADM stock at the put option's strike price of $55.00 (i.e., at a total of $5,500).

The break-even point for our example is the strike price ($55.00) less the option premium received ($1.45), i.e., $53.55. This is the price at which the seller would start to incur a loss.

On a final note, the calculation of the maximum loss assumes the put seller was assigned the option and purchased 100 shares of Archer-Daniels-Midland at the strike price of $55.00. Then, in theory, the stock could fall to zero.

If the put seller gets assigned the option, the maximum risk is similar to that of stock ownership but partially offset by the premium (of $145) received.

Bottom Line

Cash-secured put selling is a moderately more conservative strategy than buying shares of a company outright at the current market price. This strategy can be a way to capitalize on the choppiness in ADM stock in the coming weeks.

Investors who end up owning Archer-Daniels-Midland shares as a result of selling puts could further consider setting up covered calls to increase the potential returns on their shares. In other words, selling cash-secured puts could be regarded as the first step in stock ownership.

Written By: Investing.com