Attention Bargain Shoppers: The Short Portfolio That Wants To Be Long

|
Includes: AAPL, AMZN, CMG, JCI, LULU, TIF, WMT
by: SA Editor Rocco Pendola

There's nothing quite like the holiday shopping season. Sit back, twist open a beverage, fire up YouTube and watch people trample over one another to get a pack of undershirts for $2.99. It brings back memories of my Mother bludgeoning a sales associate at K-Mart over the scarcity of a day-after-Thanksgiving blue light special.

Market corrections, crashes, Armageddon - whatever this is - are quite similar to Christmas shopping mayhem. You get up at the crack of dawn and before you consider a shower or breakfast you're battling fellow citizens to get deals while they last. And, amidst the rush, concern persists in the back of your mind that if you pull the trigger too fast, Wal-Mart (NYSE:WMT) will drop the price on the 102-inch Internet-connected Active 3D THX Plasma HDTV by another three dollars.

We're living through interesting times, indeed.

Market uncertainty breeds opportunity. Let's say you're one of the investors who decided to go to "all cash" when things got crazy. Or maybe you just have a lump sum of money you want to build a portfolio with, but you're just waiting for the right time. You have to decide for yourself when it's finally time to buy. However, don't torture yourself with worry over buying too high, particularly if a considerable amount of time exists before you need your money.

The best way to long in this environment is to go short first. Because more market hiccups are likely, writing cash-secured puts could land you positions in the stocks you desire on a pull-back.

Consider what will and what could happen if you take your bankroll and use it to cover short puts:

  • Each put you write generates premium income. You keep this premium no matter what happens.
  • If you are not put shares on a contract, nothing happens. This means you run the risk of not getting long the underlying stock. If you absolutely must get long now, you're probably better off buying the stock outright.
  • If you get put shares on a contract, you must buy them at the option's strike price, regardless of the market price of the stock. For example, if you sell a $60 put and the underlying stock trades at $45 when you're assigned, your new long position starts off at a considerable on-paper loss. With that in mind, think before you select the strike you sell and be absolutely certain you will be OK owning the underlying stock at that price no matter what happens in the market.

The following examples are just that - examples. Decide for yourself the stocks you think are most attractive. Pick strike prices according to your appetite for risk and thoughts regarding where the stocks you choose will head over the next several weeks and months.

If you have $10,000 in cash ...

  • Sell Tiffany (NYSE:TIF) Sept $57.50 put for $3.50.
  • Sell Johnson Controls (NYSE:JCI) Sept $28 put for $1.35.
  • Requires $8,550 to secure the puts. $1,450 cash balance + $485 premium income.

If you have $50,000 in cash, consider all of the above plus ...

  • Sell Apple (NASDAQ:AAPL) Sept $360 put for $15.75.
  • Sell Lululemon (NASDAQ:LULU) Sept $43.75 put for $3.40.
  • Requires $48,925 to secure the puts. $1,075 cash balance + $2,400 premium income.

If you have $100,000 in cash, consider all of the above plus ...

  • Sell Amazon.com (NASDAQ:AMZN) Sept $175 put for $8.45.
  • Sell Chipotle (NYSE:CMG) Sept $280 put for $13.30.
  • Requires $94,425 to secure the puts. $5,575 cash balance + 4,575 premium income.

In all likelihood, you will not get put shares on each one of these trades. The beauty of the strategy is that after September's options expiration day, you can reassess your portfolio, see where you stand, and go short more puts on stocks you would like to own. This brings in premium income for another month as you work to construct a portfolio of stocks you would like to be long on going forward.

*I use the examples above for illustration purposes only. Prices, as of mid-morning, Eastern time, Monday, 8/22/2011.


Disclosure: I am long AAPL.

Additional disclosure: I own open AAPL bull put spreads.