Getting on the Train that Left the Station

Getting on the Train that Left the Station

Courtesy of Paul Price

We’ve all had our eyes on stocks that took off before we decided to buy. Oilfield service behemoth Schlumberger (SLB) was tempting when offered below $68 near the end of 2012. But by Valentine’s Day 2013, SLB had touched $82 without ever again venturing below $70. 

If you were waiting for a pullback, you were shut out. However, industry weakness sent SLB down to $73.08 by mid-afternoon on Tuesday. That was still more than 7.5% above the Dec. 31, 12 price, but at least down from the February high.

(Chart via Yahoo)

Screen Shot 2013-03-19 at 8.14.56 PM

 

Those who still pined for a Schlumberger position had a second chance to either make some money, or end up buying  below the originally attractive level. That was possible through the sale of a January 2014 put at the $75 strike price. 

Here are the actual stock and put option prices in effect as of 2 PM EST. 

SLB Put prices $73.08 (1)

Tuesday’s 4% drop made for high put premiums going out ten months to January of 2014. Anyone willing to commit to potentially buying 100 SLB shares could have sold a Jan. 2014 $75 put option as described below.

Final results:  Either keeping the premium, free of the stock; or keeping the premium and having to buy the stock at $75. Which case happens will depend on where SLB shares finishes on Friday, Jan. 17, 2014. 

SLB Jan. $75 puts

 

For sellers of a Jan. 2014 $75 strike put:

If SLB closes at $75 or higher on Jan. 17, 2014:

  • The put will expire worthless
  • All option obligations will disappear
  • Seller keeps the $840 premium as pure profit

If SLB closes below $75 on Jan. 17, 2014:

  • The put will be exercised
  • Seller is forced to buy  100 SLB shares for $75 per share
  • Total cost will be $7,500 for the 100 shares of SLB
  • Due to the offset of keeping the $840 premium, the 100 shares of SLB would have a net cost of $66.60 per share ($75 – $8.40 = $66.60). 

To realize the best-case scenario, SLB would only need to rise by $1.93 /share (+2.7%) from the $73.08 trade inception price. The break-even price is reduced to $66.60, 8.8% below where SLB was trading during the day.

Maximum profit for put sellers would equal to 100% of the put premium taken in at inception. If SLB fails to clear the $75 strike price on expiration, the seller will end up with a net cost that is lower than the December 31, 2012 quote. 

Think of put selling as a “Heads, I win, Tails, I buy cheaper” proposition, and the technique doesn’t seem daunting at all.

If not interested in selling a put option, I still like buying SLB at pullback prices. 

Disclosure: Long SLB shares

 

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