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)
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.
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.
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