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Options Lab: LinkedIn Corp (LNKD)

Breaking down a hypothetical trade on LNKD

by 10/29/2014 11:54:39 AM
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LinkedIn Corp (NYSE:LNKD) has struggled in 2014 -- losing 8.3% to hover near $198.86 -- but has largely trended higher since going public three-plus years ago. Therefore, the current downtrend could provide a buying opportunity for those who are bullish on the stock over the long term. Today, we'll explore one options strategy for getting in on an equity at a potentially attractive entry point, while being "paid to wait" -- specifically, the cash-secured put.

Weekly Chart of LinkedIn Corp (NYSE:LNKD) since May 2011

Imagine a trader named Whitney is long-term bullish on LNKD, but believes the shares may dip a little more before resuming their uptrend. This could include an earnings-induced tumble, as the company is scheduled to report third-quarter results tomorrow night. Specifically, Whitney believes the stock will drop to around $190 sometime in November, and has $19,000 ready to buy 100 shares, should that move lower occur.

Rather than simply waiting, however, our hypothetical trader sells to open one November 190 put at the bid price of $6.80. In so doing, she collects an initial premium of $680 (premium * number of contracts * 100 shares per contract). Should LNKD remain above $190 through November options expiration, the aforementioned put will expire worthless, meaning Whitney will pocket the premium received as her maximum potential gain. Of course, since the put remained out of the money throughout its lifetime, she won't own the shares she wants -- but $680 isn't a bad consolation prize.

On the other hand, if LNKD dips below the strike prior to November options expiration, she could be assigned. In this case, Whitney would be forced to buy the shares for $190 each -- though, after accounting for the initial net credit of $6.80, Whitney's effective entry price is $183.20 (strike less premium received). In other words, she'll be able to purchase the shares at a lower total cost than had she simply bought them outright at $190 each. Obviously, at this point, Whitney's risk-reward profile would shift from that of an options trader to that of a shareholder.

Moving along, let's compare selling cash-secured puts to a more familiar bullish strategy -- call buying. While both are used to express optimism toward an equity, the strategies have different benefits and risks. The major benefit of cash-secured put selling is the opportunity to get paid while waiting for the underlying -- in this case, LinkedIn Corp (NYSE:LNKD) -- to drop to an acceptable purchase price. There is no initial cash outlay, as there is when buying calls.

Risk, however, is potentially greater when selling puts -- as the underlying can descend well below the strike. If this happens, getting assigned could result in significant losses, only a portion of which may be covered by the initial premium received. By contrast, the risk for call buyers is limited to the initial premium paid, should the underlying remain out of the money through expiration.

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