Disclaimer: I have a short position in ESV via options. My positions may change at any time without any further updates. Please conduct your own research before considering investments based on my posts. This post is to be considered as my research and not advice or a recommendation to buy or sell any of the stocks discussed. Why I love writing Puts?
In this first post, I present my favorite option strategy - Selling Put Options. Yes, I am talking about options on a value investing website. Please read on and I am sure you will find it interesting. I will follow up with more posts on other option strategies for a value investor if there is an interest.
Often times when I like a company and want to purchase some shares, the stock is trading a bit higher than where I would like to buy. I could do several things here
1) Just wait patiently till the price comes in my buy range.
2) Place a limit order to buy the shares at a lower price.
3) Buy some shares now and add more as the price moves down OR
4) Sell puts on the shares at a lower strike price.
Let me give you an example from this week. After reading several excellent articles about Ensco International (ESV) from Ravi and Rishi, I did some due diligence of my own last weekend. I had made up my mind that the company was a good company and it was trading at an attractive valuation. Both are requirements for a good value investment. However, the shares kept trending upwards throughout this week and went from $41.8 to $45. I had tried to use option 2 above. I placed a limit order a few cents lower than the market price at the start of the day. My order never executed and I kept regretting it.
Today, with the markets down and ESV was down about 1% to $44.5. Firstly, I was tempted to user a market order and purchase the shares. Then, I looked up the Put option prices for August 2010 expiry. I considered the $42 strike which was trading at 40 cents and then I looked at the $44 strike put trading at $1.5. I decided to sell one put option for the $44 strike with August 2010 expiry and collected the $150 option premium ( less transaction costs). That’s a 3.4% premium for 2 weeks of investment.
How does it work?
· If the price of ESV remains above $44 on the expiration date which is 20th August, then I keep the $150 option premium (Options expire on the 3rd Friday of the month). If the stock has a run up and goes to $50, I will miss out on the opportunity. ( the same would happen if you would have placed a limit order)
· If ESV falls below $44, then the shares will be ‘PUT’ to me at $44 (irrespective of the price). So, say ESV fall to $42, then my effective price will be 44 – 1.5 = $42.5 ( Note the price on the date of the option is immaterial to my price since I agreed to buy at $44). If ESV shares trade down significantly, then I would have ended up buying much higher. Again, this would not be any different than using a lower price limit order. In fact, if you have done your research, the lower price gives you another attractive price point to add to your position.
Conclusion: I consider writing puts as a smart and disciplined way of purchasing shares. Investors tend to think that options (or derivatives in general) are risky and value investors have no place for them. I presented an example of one type of option that if used wisely is a good tool to have in the value investor’s toolbox.
In this first post, I present my favorite option strategy - Selling Put Options. Yes, I am talking about options on a value investing website. Please read on and I am sure you will find it interesting. I will follow up with more posts on other option strategies for a value investor if there is an interest.
Often times when I like a company and want to purchase some shares, the stock is trading a bit higher than where I would like to buy. I could do several things here
1) Just wait patiently till the price comes in my buy range.
2) Place a limit order to buy the shares at a lower price.
3) Buy some shares now and add more as the price moves down OR
4) Sell puts on the shares at a lower strike price.
Let me give you an example from this week. After reading several excellent articles about Ensco International (ESV) from Ravi and Rishi, I did some due diligence of my own last weekend. I had made up my mind that the company was a good company and it was trading at an attractive valuation. Both are requirements for a good value investment. However, the shares kept trending upwards throughout this week and went from $41.8 to $45. I had tried to use option 2 above. I placed a limit order a few cents lower than the market price at the start of the day. My order never executed and I kept regretting it.
Today, with the markets down and ESV was down about 1% to $44.5. Firstly, I was tempted to user a market order and purchase the shares. Then, I looked up the Put option prices for August 2010 expiry. I considered the $42 strike which was trading at 40 cents and then I looked at the $44 strike put trading at $1.5. I decided to sell one put option for the $44 strike with August 2010 expiry and collected the $150 option premium ( less transaction costs). That’s a 3.4% premium for 2 weeks of investment.
How does it work?
· If the price of ESV remains above $44 on the expiration date which is 20th August, then I keep the $150 option premium (Options expire on the 3rd Friday of the month). If the stock has a run up and goes to $50, I will miss out on the opportunity. ( the same would happen if you would have placed a limit order)
· If ESV falls below $44, then the shares will be ‘PUT’ to me at $44 (irrespective of the price). So, say ESV fall to $42, then my effective price will be 44 – 1.5 = $42.5 ( Note the price on the date of the option is immaterial to my price since I agreed to buy at $44). If ESV shares trade down significantly, then I would have ended up buying much higher. Again, this would not be any different than using a lower price limit order. In fact, if you have done your research, the lower price gives you another attractive price point to add to your position.
Conclusion: I consider writing puts as a smart and disciplined way of purchasing shares. Investors tend to think that options (or derivatives in general) are risky and value investors have no place for them. I presented an example of one type of option that if used wisely is a good tool to have in the value investor’s toolbox.
