Selling Puts on Value Companies (part 2)

Selling Puts on Value Companies

(Also presented in Market Shadows Newsletter, Bet with the House, Jan. 14, 13)

By Paul Price

Review and two more selling put ideas (see part 1 here

Selling (writing, shorting) puts on stocks you’d like to own is an interesting way to enter stocks at cheaper prices. If the stock price is over the strike price, we keep the “premium” we sold the put for, and we do not end up buying the stock. If the stock price is lower than the put’s strike price, we can either buy the put back or end up buying the stock at the strike price when the put expires. 

Our results will be best if the underlying shares go up or remain flat from their trade inception price. Once we’ve sold a put, there are only two outcomes that can occur at expiration.

  • If the shares are above the option’s strike price, the puts will expire worthless.
  • If the stock is below the strike price, we will be forced to buy 100 shares per contract (one contract = one put).

When puts expire worthless, the sellers of those options keep all premiums received and have no further obligations.

We would make our maximum potential profit, which equals 100% of the money received when we sold the put option.

Exercises of put options typically occur at or near expiration dates, but they can occur sooner. Timing is at the discretion of the option owner, not the seller.

Selling puts is similar to placing below-market limit orders to buy. In either case, we might, or might not, end up owning shares of the underlying stock. If the put is “put to us” – i.e. we are forced to buy 100 shares of stock per put – our entry price will be lower than had we bought the stock directly instead. In other words, if we buy the stock, we will get a cheaper price due to our collecting money from the sale of the put (the “premium”).  

MOS & LH     Option Prices 

Puts are often less actively traded than stocks. I always try to get a middle price between the bid -ask spread.

I also use expiration dates that bring in enough premium to justify the trade. The raw material we’re selling is ‘time.’ Selling even a full year costs nothing except the opportunity to move on quickly to the next trade because our money gets tied up. 

Having a one-year time horizon brings in bigger initial premiums and lower break-even points than writing shorter expiration puts.

Here is the math on two short put positions that make sense to me right now.

MOS put write details 

If MOS rises by 1.1% or better and closes above $60 on Jan. 17, 2014:

  • The put will expire worthless
  • You will keep $750 per contract as pure profit

If MOS closes below $60 on Jan. 17, 2018:

  • The put will be exercised
  • You will be forced to buy 100 shares / contract 
  • You will need to lay out $6,000 /contract in cash
  • Your net cost will be $52.50 /share or 11.5% below the trade inception price

LH put sell details 

If LH rises by 0.3% or better and closes above $87.50 on May 17, 2013:

  • The put will expire worthless
  • You will keep $400 per contract as pure profit

If LH closes below $87.50 on May 17, 2013:

  • The put will be exercised
  • You will be forced to buy 100 shares / contract 
  • You will need to lay out $8,750 /contract in cash
  • Your net cost will be $83.50 /share or 4.3% below the trade inception price

In a worst case you will end up owing 100 shares of each stock at what I’d deem a bargain price. In the best case scenario both options will expire and we’ll keep the $1,150 (total) in premiums received without having to buy anything.

New Virtual Put Selling Portfolio

Screen Shot 2013-01-14 at 1.53.00 AM 

1/11/13 Update on Virtual Put Selling Portfolio >

New: Put Selling Portfolio is here >

Disclosure: Long MOS shares, Long LH shares

 

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  1. […] Puts on Value Companies – A New Market Shadows Virtual Portfolio, Selling Puts on Value Companies (part 2), and Silver Lining Play on Tiffany’s […]

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