Seeking Alpha
Bonds, long-term horizon, dividend investing, macro
Profile| Send Message|
( followers)  

A couple months ago, in "Catch These Falling Knives By Selling Puts," I offered ideas for selling put options on any of six stocks that had declined significantly from their 2011 highs earlier in the year. As a brief review, here are the six trades from the previous article:

Computer Sciences (NYSE:CSC) - Sell the January 21, 2012 $20 puts. Potential annualized return: 25.50%

Molycorp (NYSE:MCP) - Sell the January 21, 2012 $20 puts. Potential annualized return: 26.40%

Sony Corporation (NYSE:SNE) - Sell the January 21, 2012 $15 puts. Potential annualized return: 20.00%

Diamond Foods (NASDAQ:DMND) - Sell the December 17, 2011 $25 puts. Potential annualized return: 24.00%

MGIC Investment Corporation (NYSE:MTG) - Sell the January 21, 2012 $1.50 puts. Potential annualized return: 55.98%

Bank of America (NYSE:BAC) - Sell the January 21, 2012 $4 puts. Potential annualized return: 22.50%

Now that option expiration day for January has come and gone, it is time to report on the outcome of the trades. All six of these ideas worked out to the fullest extent, as the puts for the strike prices in question all expired worthless (what you want to happen when shorting puts). An investor who sold the puts I discussed on any of the aforementioned stocks would have made 20% to nearly 56% on an annualized basis, depending on the stock, and not been forced to purchase any of the securities. Additionally, none of the six stocks ever even traded below the strike prices mentioned in my previous article.

I recognize that annualized gains are ultimately most impressive when one can replicate them over an entire year rather than just a couple months of the year. Even though it can get a little tricky selling puts during the heart of earnings season, after a large multi-week rally in the major indices and with market-wide volatility having declined significantly from the last time I presented short put ideas, there are still a few opportunities worth mentioning.

Of the three ideas I present below, only one company comes from the six companies mentioned in my previous article. Given how much BofA and MGIC have rallied, I would not be interested in selling puts on those stocks at this time. Given that results from neither Diamond Foods' internal audit nor the SEC's investigation were expected by December's expiration date, it seemed reasonable to sell the December puts back in mid-to-late November. Now, however, given that it has been a couple months, and news on the audit or the investigation might break at any time, staying away from this stock seems prudent.

Selling Sony's $15 puts is still something to keep in mind, but currently, looking out a couple months, it's hard to get excited about the premiums being offered to the put seller. Regarding Molycorp, it's tempting to sell the March $19, $20, or $21 puts, but given the company's volatility, how much the overall markets have rallied of late, the generally low market-wide volatility, and the fact that Molycorp reports earnings before March expiration, this type of trade should be reserved for those with strong convictions about how Molycorp's earnings report will turn out.

That leaves just one company, Computer Sciences, with puts that make my new list. This company has had a host of difficult news over the past several months, yet the stock is holding its own right around the 2002 and 2008 lows. It is possible the company's nearly 60% decline from its 52-week high to its 52-week low has priced in the known and expected bad news. However, because of the overall market's strength during the past month, the possibility of a pullback taking Computer Sciences with it, and the fact that Computer Sciences reports earnings before the March options expiration day, I'd be more comfortable selling puts below the 2002 and 2008 lows, rather than closer to at-the-money.

The March 17, 2012 $20 puts are currently bidding 65 cents. If on March options expiration day, the stock closes no more than 23.66% below its recent price of $26.20, the puts will expire worthless, and the put seller will keep the entire premium. If it closes below $20, the put seller will be assigned the shares (assuming the put position hasn't already been closed), and the cost basis, ex-commissions, will be $19.35 ($20 minus 65 cents). The dividend yield on a cost basis of $19.35 in Computer Sciences would currently be 4.13%. Assuming the puts expire worthless, in a cash account, this trade will bring in 3.25% in 54 days, a 22.03% annualized return.

For the investor looking to take on a bit more risk, selling the March 17, 2012 $22.50 puts is an idea worth exploring. These puts are currently bidding $1.05, so if they expire worthless, the put seller will collect 4.67% in 54 days, a 31.63% annualized return. In order for an assignment to take place on the puts, Computer Sciences would have to decline more than 14.12% from current levels (assuming the put position hadn't already been closed). Upon assignment, the cost basis, ex-commissions, would be $21.45 ($22.50 minus $1.05), a level 18.13% below Computer Sciences' price at the time this article was written.

Best Buy (NYSE:BBY) was recently trading at $25.45, down 28.21% from its 52-week high and down 47.88% from its April 26, 2010 high of $48.83. Best Buy's 52-week low of $21.79 came on October 4, 2011, when the major averages found bottoms as well. Given that Best Buy doesn't report earnings until after March options expiration day, the March 17, 2012 $22 and $23 puts are worth considering from the short side.

As of Friday's close, the March 17, 2012 $22 put option was bidding 34 cents. On Monday, Best Buy rallied, and the options declined in value. If the $22 put option returns to a bid of 34 cents, and if on March options expiration day, the stock closes no more than 12% lower than its January 20 close (when the puts were bidding 34 cents), the puts will expire worthless, and the put seller will keep the entire premium. If it closes below $22, the put seller will be assigned the shares (assuming the put position hasn't already been closed), and the cost basis, ex-commissions, will be $21.66 ($22 minus 34 cents). The dividend yield on a cost basis of $21.66 in Best Buy would currently be 2.95%.

On the other hand, for the investor looking to immediately enter a short put trade on Best Buy, the $23 put option currently bidding 39 cents is worth exploring. If on March options expiration day, the stock closes no more than 9.63% lower than its current level, the puts will expire worthless, and the put seller will keep the entire premium. If it closes below $23, the put seller will be assigned the shares (assuming the put position hasn't already been closed), and the cost basis, ex-commissions, will be $22.61 ($23 minus 39 cents). The dividend yield on a cost basis of $22.61 in Best Buy would currently be 2.51%. Assuming the puts expire worthless, in a cash account, this trade will bring in 1.696% in 54 days, an 11.49% annualized return.

When dealing with the equity or options of companies with junk-rated debt, tread carefully. Alpha Natural Resources (NYSE:ANR) is one such company. Alpha Natural Resources recently traded at $20.83, down 66.22% from its 52-week high and down 69.39% from its 2011 high of $68.05. Its 52-week low of $15.49 came on October 4, 2011, when the major averages found bottoms. Given that Alpha Natural Resources doesn't report earnings until after February options expiration day, the February 18, 2012 $16 and $17 puts are worth considering from the short side.

As of Friday's close, the February 18, 2012 $16 put option was bidding 25 cents. On Monday, Alpha Natural Resources rallied, and the options declined in value. If the $16 put option returns to a bid of 25 cents, it would be an intriguing consideration. For the investor looking for short put trades to enter immediately, the February 18, 2012 $17 put option, currently bidding 23 cents is one possibility. If on February options expiration day, the stock closes no more than 18.39% lower than its recent trade of $20.83, the puts will expire worthless, and the put seller will keep the entire premium. If it closes below $17, the put seller will be assigned the shares (assuming the put position hasn't already been closed), and the cost basis, ex-commissions, will be $16.77 ($17 minus 23 cents). Assuming the puts expire worthless, in a cash account, this trade will bring in 1.353% in 26 days, a 19.05% annualized return.

I should note that given where market-wide volatilities are today, relative to where they were in November when my previous ideas were offered, there may be better entry points at the strike prices discussed in the article. I searched through countless equities and options for ideas worth presenting given today's prices and today's volatility levels and found it quite difficult to find much worth mentioning. As the year progresses, I'm sure other opportunities will present themselves.

Source: Options: Did You Catch These Falling Knives?