Investors eyeing a purchase of Reynolds American Inc (RAI) stock, but cautious about paying the going market price of $49.28/share, might benefit from considering selling puts among the alternative strategies at their disposal. One interesting put contract in particular, is the January 2015 put at the $40 strike, which has a bid at the time of this writing of $1.85. Collecting that bid as the premium represents a 4.6% return against the $40 commitment, or a 3.5% annualized rate of return (at Stock Options Channel we call this the YieldBoost).
Selling a put does not give an investor access to RAI'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 $40 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 Reynolds American Inc sees its shares decline 18.9% and the contract is exercised (resulting in a cost basis of $38.15 per share before broker commissions, subtracting the $1.85 from $40), the only upside to the put seller is from collecting that premium for the 3.5% annualized rate of return.
Below is a chart showing the trailing twelve month trading history for Reynolds American Inc, and highlighting in green where the $40 strike is located relative to that history: