Riding the Bull by Writing Puts on Large-Caps - Barron's

Annotated article summary from this weekend's Barron's. Receive all our Barron's summaries by signing up here:

A Strategy Built for Bulls by Steven M. Sears

Summary: Goldman Sachs' (GS) portfolio strategist David Kostin thinks Q2 earnings forecasts are low. He likes big-caps due to their greater global exposure and cleaner balance-sheets, which make them less sensitive to interest rate volatility. He says big stocks are at the bottom of 20-year P/E and price-to-book ratios, and notes hedge funds have begun moving into large-caps. Goldman options strategists Maria Grant and John Marshall scanned for big-cap ($40B-plus) companies with especially high volatility premiums. They suggest selling three-month puts on: Target (TGT), AT&T (T), PepsiCo (PEP), Coca-Cola (KO), Comcast (CMCSA), Oracle (ORCL), Sears (S), IBM (IBM), Wells Fargo (WFC), Merrill Lynch (MER), Johnson & Johnson (JNJ), Morgan Stanley (MS), Amgen (AMGN), General Electric (GE), and Disney (DIS). At best, the trade pays off with extra cash. At worst, you're left with quality stocks.

Related Links: Wikipedia on put options • Magazine Covers: The #1 Contrarian Indicator? • Using Options on ETFs

Comments

[k_denninger]

Quality stocks for which you overpaid, perhaps dramatically, if things don't go your way.

Somehow that doesn't sound so great.

[NO DooDahs]

Let's just assume that someone bullish and 100% long takes this "advice" from the "gurus" at Barron's, and sells some $50 puts on KO. If things go really wrong, and KO falls to $45, then for every single put contract they sold, they'd have to buy 100 shares of KO for $5000 when those shares were trading for $4500. So either you're stuck with ponying up all the money and keeping the shares, which will be underwater, or you have to pony up $500 in cash for each contract's loss.

And what's the upside? You get to keep the premium you sold the puts for.

It's hard not to cuss at an idea that is this stupid. Limited upside, unlimited risk. Makes me glad I don't subscribe to Barron's.

Here's an idea: if you're bullish, BUY. Buy shares or buy calls or buy futures. Limited downside and unlimited upside.

[mbur18]

By selling a put instead of buying the share you do sacrifice the upside potential, but your risk is actually a bit less than buying the shares. Say KO is trading at 52: if you sell a 50 put for $1 and the stock falls to 45 at expiration, you're down $400 net. If you bought at 52, you'd be down $700.

[Josh Stern]

The writing puts strategy makes sense only in the following situation: 1) you want to own the stock anyway, 2) your are short term neutral on the outlook for the stock or the market, and 3) you think current implied volatility on the options is too high. If the amount of shares you are writing puts on is equal to the number you would otherwise buy, then the strategy isn't really any riskier than a long position - you can always buy the put back just as you could always sell the long and the maximum possible loss is the same.

What I find embarrasing is the idea that a fund manager would mention this in Barron's as their strongest investment idea. In that case, they should really think about returning their cash to their shareholders.