Don’t Be Afraid of Stocks Under $10. Do This Instead.

By: Keith Kaplan

Jul 08, 2021 | EducationalInvesting Strategies

There’s something about stocks trading under $10 that people are biased against. 

Even some of the world’s top money managers have dismissed stocks trading in single digits. Instead, they’ll snidely remark that there must be a reason why a stock is so cheap. 

There could be many reasons why a stock trades under $10. For example, it could be a matter of how many shares are outstanding. On the other hand, it might be that the stock used to be at a very high price. 

Listen. When you eat chicken, do you honestly care if it’s cut up into 50 pieces or three? 

There’s a weird bias that many people don’t think about. But there are many companies that I would consider owning despite a lower share price. 

Let me show you two stocks that have two very similar profiles – one that’s under $10 and another that is trading near triple digits.

I’d consider owning both. 

But in today’s choppy environment, I want to ensure that I get the most bang for my buck. 

Gerdau Versus Nucor

Today, I’m looking at two steel stocks. 

Steel stocks have pulled back since the height of the mania around infrastructure stocks in May. However, with steel prices rising due to an improving economy and supply chain shocks, it was a strong first half in the steel space. 

Gerdau S.A. (GGB) is a Brazilian-based steel manufacturer. Looking at TradeSmith Finance, this stock traded at $5.68 per share early on Wednesday. The company has a solid balance sheet. It has a Piotroski F-score of 8, operating margins above 16.5%, and trades at attractive valuation multiples. 

Nucor Corp. (NUE) is a U.S.-based steel company with operations based in North Carolina. Its stock traded at $95.59 per share on Wednesday. It turns out, though, that its balance sheet is a little less attractive. Its F-score is lower at 6. Its operating margins are under 11.5%. And its valuation margins are a little more stretched than its Brazilian rival. 

Both companies are trading in the Green Zone right now on TradeSmith Finance. In addition, both are in a solid green uptrend. But even though Gerdau’s stock price is cheaper, it looks like a better overall investment based on the numbers. 

How I Might Want to Trade Gerdau

There are many ways that I could trade this company. 

First, I could purchase 100 shares for $571 as of market close on Wednesday. 

Second, I could buy a long-dated call option and take my chances that the stock will rise despite the recent volatility in the market. 

Or I could park some money on the side and collect income using something known as a cash-secured put.  I love this strategy for cheap stocks that I’m happy to own. 

A put is a contract that grants the buyer the right, but not the obligation, to sell 100 shares of a stock on a specific date (expiration date) at a specific price. 

So, if I’m looking at the options chain of Gerdau S.A., I can look out to Sept. 17, 2021. That is 72 days away (or one-fifth of the year). I can sell a cash-secured put for Gerdau at $5.00 and receive $0.20 in premium per share.

Given that each contract is worth 100 shares, I would receive $20 in cash today. 

If the stock falls to $5.00 on or before that day, the contract buyer has the right – but not the obligation – to sell me all 100 shares of the stock. I would then use the $500 that I’ve set aside when I sold the put and take possession of the stock. 

Remember, it’s a stock that I want to buy because I want to have an investment and exposure to steel stocks over the long term. 

But if it doesn’t fall to that level and the contract expires worthless, I’ll receive $20 for every 100 shares that I could have bought for $500, representing a return on my investment of $20/$500 or a 4%. Annualized, that’s a return of roughly 20%, given the initial 72-day holding period.

An Easier Way to Trade in Cheaper Stocks

It’s very important to learn how to use this strategy. Cheap stocks don’t require me to put up as much margin. But I can also build larger or smaller positions based on how much I want to buy. 

I don’t think cash-secured puts are just a way to generate income on stocks that I want to own. I see them as a way to pick the very stocks that I want to own at the price that I want to pay. 

So, I can be very conservative with this strategy by constantly focusing on stocks trading in the Buy Zone on TradeSmith Finance with positive momentum.

I’ll be back tomorrow to discuss another interesting way to use options and reduce risk across the board. 

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