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Never does nature say one thing and wisdom another. Juvenal, Satires

The selling of naked puts is a great way to open a second stream of income.

One usually sells a put option if one's outlook on the underlying security is bullish. The buyer of the put option pays the seller a premium for the right to sell the shares at an agreed-upon price. If the stock does not trade at or below the agreed-upon price (strike price, price) the seller gets to keep the premium.

Benefits associated with selling naked puts

  1. In essence, you get paid for entering a "limit order" for stock or stocks you would not mind owning.
  2. It allows one to generate income in a neutral or rising market.
  3. When one sells a naked put, in effect, one takes on the position of an insurance sales representative. One agrees to buy the stock in the future if it drops to a certain level before the option expires. For this, one is paid a premium upfront and if one repeats this strategy over and over again these premiums can really boost one's returns over time.
  4. Acquiring stocks via short puts is a widely used strategy by many retail traders and is considered to be one of the most conservative option strategies. This strategy is very similar to the covered call strategy.
  5. The safest option is to make sure the put is "cash secured." This simply means that you have enough cash in the account to purchase that specific stock at the agreed-upon price if the stock trades below the strike price. Actually, your final price would be a tad bit lower when you add the premium you were paid up front into the equation. For example, if you sold a put at a strike of 20 with two months of time left on it for $2.50, $250 per contract sold would be deposited in your account.
  6. Time is on your side. Every day you profit via time decay as long as the stock price does not drop significantly. In the event it does drop below the strike you sold the put at; you get to buy a stock you like at the price you wanted.
  7. Most options expire worthless so time is on your side. Time decay is the greatest in the front month, but the premium will not be as high as the puts that have more time them. However, this can be compensated for by repeating the strategy again and again. It involves more work but the potential gains one can lock in could make it worth the extra effort.

The majority of traders opt to close the put out prior to expiration if they have the chance of buying it back at much lower price. For example, selling the put at $2.50 and buying it back at $0.50.

Warning

This strategy should not be employed on speculative stocks or stocks that have weak fundamentals and or the technical picture is weak. In other words you should only use this strategy if you really want to own the stock but want to purchase it at a lower price

Reasons to like on Royal Gold, Inc. (NASDAQ:RGLD):

  • It has a good dividend five year growth rate of 13.5%.
  • A good fiver year EPS growth rate of 14.35%.
  • Consecutive dividend increases for 10 years.
  • A positive levered free cash flow of $5.13 million.
  • Net income has almost doubled since 2009; in 2011 it stood at $71 million compared to $38 million in 2009.
  • Projected year over year growth rates for 2012 and 2013 of 40.6% and 20.9% respectively.
  • Cash flow per share has doubled from $1.25 in 2009 to $2.55 in 2011.
  • A good quarterly earnings and revenue growth rate of 27% and 22% respectively.
  • It sports a great quick and current ratio of 5.5 and 5.87 respectively.
  • It has an excellent payout ratio of 28%.
  • A strong five year sales growth of 41%.
  • EBTIDA has increased from $97 million in 2009 to $191 million in 2011.
  • Cash flow from operating activities has surged almost 500% from its 2009 levels of $30.5 million in comparison to the 2011 figure of $146 million.
  • A low long term debt to equity ratio of 0.18.
  • A strong total 3 and 5 year total return of 67% and 106%.
  • An excellent interest coverage ratio of 20.
  • A decent free cash flow yield of 5.03%.
  • 100K invested for 10 years would have grown into a whopping $1.34 million.

Suggested strategy for selling naked puts on Royal Gold

Ideally, one should wait for Royal Gold to pullback to the 59-60 ranges before selling naked puts.

The July 55 2012 option is trading in the 1.35-1.45 ranges and so a pullback to the 59-60 ranges should push the price up as much as 1.50. We will assume that the price moves up by only 75 cents from $1.40 to $2.15. Once you sell this option, $215 will be deposited into your account per contract. Please remember with this strategy you are waiting for the stock to drop to the 59-60 ranges before you attempt to sell the puts.

If the stock does not trade below 55, you get to keep the premium which works out for a gain of roughly 4% for a period of three months. If the stock does trade below 55, you will be assigned the shares in a stock you wanted to own and a price you are happy with. In this instance, your final price will work out $52.85 (55 - premium of $2.15).

One could adjust this strategy, and sell puts with different strike prices if Royal Gold pulls back to the 59-60 ranges. For example, you could sell puts with strikes at 52.50 or 50.00.

The benefit of this strategy you are getting paid to wait on a "limit order." order."

If you are bullish on this stock at current prices, then you could sell puts immediately instead of waiting for a pullback.

Royal Gold, Inc.

Levered Free Cash Flow: 5.13M

  1. Net income for the past three years
  2. Net Income 2009 = $38 million
  3. Net Income 2010 = $21 million
  4. Net Income 2011 = $71 million
  1. EBITDA 12/2011 = $191 million
  2. EBITDA 12/2010 = $101 million
  3. EBITDA 12/2009 = $97 million
  4. Net income Reported Quarterly = $231 million
  1. Total cash flow from operating activities
  2. 2009 = $30.05 million
  3. 2010 = $48.38 million
  4. 2011 = $146.96 million
  1. Cash Flow 12/2011 = 2.55 $/share
  2. Cash Flow 12/2010 = 1.7 $/share
  3. Cash Flow 12/2009 = 1.25 $/share
  1. Anl EPS before NRI 12/2009 = 0.52
  2. Anl EPS before NRI 12/2008 = 0.84
  3. Anl EPS before NRI 12/2007 = 0.79

Performance

  1. ROE = 6.3%
  2. Return on Assets = 4.6%
  3. Quarterly Earnings Growth = 27.8%
  4. Quarterly Revenue Growth = 22.2%
  1. Price to Sales = 14.44
  2. Price to Book = 2.40
  3. Price to Tangible Book = 2.40
  4. Price to Cash Flow = 22.60
  1. Current Ratio 09/2011 = 5.5
  2. Current Ratio 5 Year Average = 17.39
  3. Quick Ratio = 5.87
  4. Cash Ratio = 4.17
  5. Interest Coverage =20
  6. Total return last 3 years = 67%
  7. Total return last 5 years = 106%

Divided history and sustainability

  1. Payout Ratio 09/2011 = 0.28
  2. Payout Ratio 06/2011 = 0.3
  3. Payout Ratio 5 Year Average 09/2011 = 0.41
  4. Change in Payout Ratio = -0.13
  5. Dividend Yield= 1.00%
  6. Dividend growth rate5 year average = 13.57%
  7. Consecutive dividend increases = 10 years

Company: Transocean Ltd (NYSE:RIG)

Basic Key ratios

  1. Percentage Held by Insiders = 0.03
  2. Relative Strength 52 weeks = 27
  3. Cash Flow 5 -year Average = 13.71
  4. Dividend Yield 5-Year Average = 0.92

Growth

  1. Net Income ($mil) 12/2011 = -5725
  2. Net Income ($mil) 12/2010 = 961
  3. Net Income ($mil) 12/2009 = 3181
  1. EBITDA ($mil) 12/2011 = 1945
  2. EBITDA ($mil) 12/2010 = 4494
  3. EBITDA ($mil) 12/2009 = 6098
  4. Cash Flow ($/share) 12/2011 = 19.45
  5. Cash Flow ($/share) 12/2010 = 14.05
  6. Cash Flow ($/share) 12/2009 = 16.73
  1. Sales ($mil) 12/2011 = 9142
  2. Sales ($mil) 12/2010 = 9576
  3. Sales ($mil) 12/2009 = 11556
  1. Annual EPS before NRI 12/2007 = 11.6
  2. Annual EPS before NRI 12/2008 = 14.34
  3. Annual EPS before NRI 12/2009 = 11.39
  4. Annual EPS before NRI 12/2010 = 5.75
  5. Annual EPS before NRI 12/2011 = 1.06

Dividend history

  1. Dividend Yield = 6.47
  2. Dividend Yield 5 Year Average 12/2011 = 0.92
  3. Annual Dividend 12/2010 = 0
  4. Forward Yield = 6.47

Dividend sustainability

  1. Payout Ratio 06/2011 = 2.15
  2. Payout Ratio 5 Year Average 12/2011 = 0.21
  3. Change in Payout Ratio = 1.94

Performance

  1. Percentage Change Price 52 Weeks Relative to S&P 500 = -37.94
  2. Next 3-5 Year Estimate EPS Growth rate = 9.5
  3. EPS Growth Quarterly(1)/Q(-3) = 168.33
  4. ROE 5 Year Average 12/2011 = 19.17
  5. Return on Investment 06/2011 = 1.61
  6. Debt/Total Cap 5 Year Average 12/2011 = 35.87
  1. Current Ratio 06/2011 = 1.42
  2. Current Ratio 5 Year Average = 1.46
  3. Quick Ratio = 1.3
  4. Cash Ratio = 0.9
  5. Interest Coverage Quarterly = N/A

Valuation

  1. Book Value Quarterly = 42.97
  2. Price/ Book = 1.14
  3. Price/ Cash Flow = 2.51
  4. Price/ Sales = 1.87
  5. EV/EBITDA 12 Mo = 12.65

Company: ABB Ltd (NYSE:ABB)

Levered Free Cash Flow = $1.56B

Basic Key ratios

  1. Relative Strength 52 weeks = 39
  2. Dividend 5-year Growth = 39.46
  3. Cash Flow 5 -year Average = 1.49
  4. Dividend Yield 5-Year Average = 1.15

Growth

  1. Net Income ($mil) 12/2011 = 3168
  2. Net Income ($mil) 12/2010 = 2561
  3. Net Income ($mil) 12/2009 = 2901
  1. EBITDA ($mil) 12/2011 = 5752
  2. EBITDA ($mil) 12/2010 = 4615
  3. EBITDA ($mil) 12/2009 = 4902
  1. Cash Flow ($/share) 12/2011 = 1.88
  2. Cash Flow ($/share) 12/2010 = 1.45
  3. Cash Flow ($/share) 12/2009 = 1.52
  1. Sales ($mil) 12/2011 = 37990
  2. Sales ($mil) 12/2010 = 31589
  3. Sales ($mil) 12/2009 = 31795
  1. Annual EPS before NRI 12/2009 = 1.26
  2. Annual EPS before NRI 12/2010 = 1.15
  3. Annual EPS before NRI 12/2011 = 1.46

Dividend history

  1. Dividend Yield = 3.60
  2. Dividend Yield 5 Year Average 12/2011 = 1.15
  3. Annual Dividend 12/2011 = 0.63
  4. Forward Yield = 6.91
  5. Dividend 5 year Growth = 45%

Dividend sustainability

  1. Payout Ratio 06/2011 = 0.44
  2. Payout Ratio 5 Year Average 12/2011 = 0.18
  3. Change in Payout Ratio = 0.27

Performance

  1. Percentage Change Price 52 Weeks Relative to S&P 500 = -23.07
  2. Next 3-5 Year Estimate EPS Growth rate = 11.6
  3. EPS Growth Quarterly(1)/Q(-3) = -137.93
  4. ROE 5 Year Average 12/2011 = 24.68
  5. Return on Investment 06/2011 = 17.27
  6. Debt/Total Cap 5 Year Average 12/2011 = 15.03
  1. Current Ratio 06/2011 = 1.40
  2. Current Ratio 5 Year Average = 1.56
  3. Quick Ratio = 1.09
  4. Cash Ratio = 0.44
  5. Interest Coverage Quarterly = 32.8

Company: Silverwork Metal (NYSE:SVM)

Basic Key ratios

  1. Relative Strength 52 weeks = 17
  2. Dividend 5-year Growth = 10.27
  3. Cash Flow 5 -year Average = 0.29
  4. Dividend Yield 5-Year Average = 1.26

Growth

  1. Net Income ($mil) 12/2011 = 69
  2. Net Income ($mil) 12/2010 = 39
  3. Net Income ($mil) 12/2009 = N/A
  1. EBITDA ($mil) 12/2011 = 118
  2. EBITDA ($mil) 12/2010 = 65
  3. EBITDA ($mil) 12/2009 = N/A
  4. Cash Flow ($/share) 12/2011 = 0.41
  5. Cash Flow ($/share) 12/2010 = 0.26
  6. Cash Flow ($/share) 12/2009 = N/A
  1. Sales ($mil) 12/2011 = 167
  2. Sales ($mil) 12/2010 = 107
  3. Sales ($mil) 12/2009 = N/A
  1. Annual EPS before NRI 12/2009 = 0.18
  2. Annual EPS before NRI 12/2010 = 0.24
  3. Annual EPS before NRI 12/2011 = 0.38

Dividend history

  1. Dividend Yield = 1.5
  2. Dividend Yield 5 Year Average 12/2011 = 1.26
  3. Annual Dividend 12/2011 = 0.08
  4. Forward Yield = 1.5
  5. Dividend 5 year Growth 12/2011 = 10.27

Dividend sustainability

  1. Payout Ratio 06/2011 = 0.21
  2. Payout Ratio 5 Year Average 12/2011 = 0.28
  3. Change in Payout Ratio = -0.08

Performance

  1. Percentage Change Price 52 Weeks Relative to S&P 500 = -55.61
  2. EPS Growth Quarterly(1)/Q(-3) = -171.43
  3. ROE 5 Year Average 12/2011 = 18.35
  4. Return on Investment 06/2011 = 17.12
  5. Debt/Total Cap 5 Year Average 12/2011 = 0.9
  1. Current Ratio 06/2011 = 4.09
  2. Current Ratio 5 Year Average = 5.01
  3. Quick Ratio = 5.77
  4. Cash Ratio = 5.66
  5. Interest Coverage Quarterly = N/A

Company: Annaly Capital Management (NYSE:NLY)

Basic Key ratios

  1. Percentage Held by Insiders = 1
  2. Relative Strength 52 weeks = 51
  3. Dividend 5-year Growth = 15.62
  4. Cash Flow 5 -year Average = 2.07
  5. Dividend Yield 5-Year Average = 13.12

Growth

  1. Net Income ($mil) 12/2011 = 344
  2. Net Income ($mil) 12/2010 = 1267
  3. Net Income ($mil) 12/2009 = 1961
  1. EBITDA ($mil) 12/2011 = 1691
  2. EBITDA ($mil) 12/2010 = 2400
  3. EBITDA ($mil) 12/2009 = 2828
  4. Cash Flow ($/share) 12/2011 = 3.17
  5. Cash Flow ($/share) 12/2010 = 3.39
  6. Cash Flow ($/share) 12/2009 = 3.25
  1. Sales ($mil) 12/2011 = 1120
  2. Sales ($mil) 12/2010 = 2635
  3. Sales ($mil) 12/2009 = 3424
  1. Annual EPS before NRI 12/2009 = 2.76
  2. Annual EPS before NRI 12/2010 = 2.31
  3. Annual EPS before NRI 12/2011 = 2.57

Dividend history

  1. Dividend Yield = 13.84
  2. Dividend Yield 5 Year Average 12/2011 = 13.12
  3. Annual Dividend 12/2011 = 2.44
  4. Annual Dividend 12/2010 = 2.65
  5. Forward Yield = 13.84
  6. Dividend 5 year Growth 12/2011 = 15.62

Dividend sustainability

  1. Payout Ratio 06/2011 = 0.89
  2. Payout Ratio 5 Year Average 12/2011 = 1.04
  3. Change in Payout Ratio = -0.15

Performance

  1. Percentage Change Price 52 Weeks Relative to S&P 500 = -12.39
  2. Next 3-5 Year Estimate EPS Growth rate = 2
  3. EPS Growth Quarterly(1)/Q(-3) = 123.53
  4. ROE 5 Year Average 12/2011 = 15.04
  5. Return on Investment 06/2011 = 14.32
  6. Debt/Total Cap 5 Year Average 12/2011 = 3.2
  1. Current Ratio 06/2011 = 0.04
  2. Current Ratio 5 Year Average = 0.04
  3. Quick Ratio = 0.04
  4. Cash Ratio = 0.02
  5. Interest Coverage Quarterly = N/A

Conclusion

On all the suggested candidates, one could do even better if one waited for the markets to pull back strongly before selling naked put. First of all, the put premiums will rise due to the "fear factor" and if assigned the shares you would end up getting in at mouth watering price.

Disclaimer

This list of stocks is meant to serve as a starting point. Please do not treat this as a buying list. It is imperative that you do your due diligence and then determine if any of the above plays meet with your risk tolerance levels. The Latin maxim caveat emptor applies - let the buyer beware.

Source: Royal Gold Among 5 Attractive Naked Put Plays

Additional disclosure: EPS, EPS surprise, broker recommendations, and price and consensus charts sourced from zacks.com. A significant portion of the historic data was obtained from zacks.com. Option table sourced from yahoofinance.com. Earnings estimates and growth tables sourced from dailyfinance.com.