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A single conversation with a wise man is better than 10 years of study.

Chinese Proverb

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. 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.

One option to keep in mind

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.

ArcelorMittal is our play of choice to sell naked puts on for the following reasons:

  • A good five dividend growth rate of 12.59%.
  • A five-year cash flow average of 9.31.
  • Sales increased from $65 billion in 2009 to $93.9 billion in 2011.
  • It has a good long-term debt to equity ratio of 0.42.
  • It has a decent yield of 3.9%, which is well above the official inflation rate.
  • A great payout ratio of 38%.
  • Net income surged from $75 million in 2009 to a stunning $2.25 billion in 2011.
  • EBITDA increased from $1.02 billion in 2009 to $9.2 billion in 2011.
  • It has a massive levered free cash flow of $4.23 billion.
  • Cash flow per share increased from $4.88 in 2009 to $5.04 in 2011.
  • A high beta of 2.65 which makes it a good candidate for covered writes. Selling covered calls open up a second stream of income. If one is bullish on the stock, then the high beta is also good for selling naked puts.
  • A five average payout ratio of only 25%.
  • It has an estimated 3-5 year EPS projected growth rate of 21%.
  • An acceptable quick and current ratio of 1.50 and 1.39 respectively.
  • $100K invested for 10 years would have grown to $1.05 million.

Suggested strategy for selling Naked puts on ArcelorMittal

Wait for it for it to pull back and test 15.00 ranges and then sell naked puts with roughly 3-6 months of time left on them. Right now the stock is trading at 17.25. The Sept. 14, 2012 puts are trading in the $0.83-$0.86 ranges and so if it were to drop down to 15, the premium would rise anywhere from $1.00-$2.00 depending on how much time was left on this option. Let's assume that the option only moves up by $1.25 from $0.83to $2.08. If one sold this option (assuming MT drops to $15) then $208 per contract would be deposited in your account.

Now if the stock does not trade below 14 you would walk away with the premium, and a gain of roughly 13%. This gain is calculated with a $15 stock price because it is at this point you would be triggered into selling this put based on the above strategy. If the stock does trade below 14, you will be assigned the shares. Your final price will be the strike minus the premium you were paid. In this case your cost would be $12.98.

You could choose to sell options with lower strikes also, say in the 12 and 13 ranges. The benefit of this strategy is two-fold. First you are waiting for the stock to pull back to a certain price before you sell the put and secondly you are getting paid to wait on a "limit order."

If you are bullish on this stock at current prices then you could sell puts with strikes in the 15 or 16.

Company: ArcelorMittal (NYSE:MT)

Levered Free Cash Flow = $4.32B

Basic Key ratios

  1. Percentage Held by Insiders = 0.06
  2. Relative Strength 52 weeks = 17
  3. Dividend 5-year Growth = -12.59
  4. Cash Flow 5 -year Average = 9.31
  5. Dividend Yield 5-Year Average = 2.70

Growth

  1. Net Income ($mil) 12/2011 = 2259
  2. Net Income ($mil) 12/2010 = 3005
  3. Net Income ($mil) 12/2009 = 75
  4. 12months Net Income this Quarterly/12 months Net Income 4Q's ago = -23.37
  5. Quarterly Net Income this Quarterly/same Quarter year ago = -28.21
  1. EBITDA ($mil) 12/2011 = 9294
  2. EBITDA ($mil) 12/2010 = 7829
  3. EBITDA ($mil) 12/2009 = 1020
  4. Net Income Reported Quarterly ($mil) = -1000
  5. Annual Net Income this Yr/ Net Income last Yr = -24.83
  6. Cash Flow ($/share) 12/2011 = 5.04
  7. Cash Flow ($/share) 12/2010 = 4.64
  8. Cash Flow ($/share) 12/2009 = 4.88
  1. Sales ($mil) 12/2011 = 93973
  2. Sales ($mil) 12/2010 = 78025
  3. Sales ($mil) 12/2009 = 65110
  1. Annual EPS before NRI 12/2009 = 1.5
  2. Annual EPS before NRI 12/2010 = 1.68
  3. Annual EPS before NRI 12/2011 = 1.8

Dividend history

  1. Dividend Yield = 3.90
  2. Dividend Yield 5 Year Average 12/2011 = 2.7
  3. Annual Dividend 12/2011 = 0.64
  4. Annual Dividend 12/2010 = 0.64
  5. Forward Yield = 3.79
  6. Dividend 5 year Growth 12/2011 = -12.59

Dividend sustainability

  1. Payout Ratio 06/2011 = 0.36
  2. Payout Ratio 5 Year Average 12/2011 = 0.25
  3. Payout Ratio 5 Year Average 09/2011 = 0.25
  4. Payout Ratio 5 Year Average 06/2011 = 0.24
  5. Change in Payout Ratio = 0.11

Performance

  1. Percentage Change Price 52 Weeks Relative to S&P 500 = -54.53
  2. Next 3-5 Year Estimate EPS Growth rate = 21.29
  3. EPS Growth Quarterly(1)/Q(-3) = 152.5
  4. ROE 5 Year Average 12/2011 = 11.19
  5. Return on Investment 06/2011 = 3.66
  6. Debt/Total Cap 5 Year Average 12/2011 = 27.51
  1. Current Ratio 06/2011 = 1.5
  2. Current Ratio 5 Year Average = 1.39
  3. Quick Ratio = 0.58
  4. Cash Ratio = 0.31
  5. Interest Coverage Quarterly = 1.90

Valuation

  1. Book Value Quarterly = 38.75
  2. Price/ Book = 0.43
  3. Price/ Cash Flow = 3.34
  4. Price/ Sales = 0.28
  5. EV/EBITDA 12 Mo = 4.95

Other interesting plays to sell Naked puts on

Royal Gold, Inc. (NASDAQ:RGLD)

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 = 14.29
  2. Price to Book = 2.38
  3. Price to Tangible Book = 2.38
  4. Price to Cash Flow = 22.40
  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

Divided history and sustainability

  1. Payout Ratio 09/2011 = 0.28
  2. Payout Ratio 5 Year Average 09/2011 = 0.41
  3. Dividend growth rate5 year average = 13.57%

Company: Yamane Gold Inc (NYSE:AUY)

Basic Key ratios

  1. Percentage Held by Insiders = 2.7
  2. Relative Strength 52 weeks = 78
  3. Dividend 5-year Growth = 37.41
  4. Cash Flow 5 -year Average = 0.69
  5. Dividend Yield 5-Year Average = 0.7

Growth

  1. Net Income ($mil) 12/2011 = 548
  2. Net Income ($mil) 12/2010 = 451
  3. Net Income ($mil) 12/2009 = 193
  4. 12months Net Income this Quarterly/12 months Net Income 4Q's ago = 21.46
  5. Quarterly Net Income this Quarterly/same Quarter year ago = -44.14
  6. Cash Flow ($/share) 12/2011 = 1.43
  7. Cash Flow ($/share) 12/2010 = 1.01
  8. Cash Flow ($/share) 12/2009 = 0.79
  1. Sales ($mil) 12/2011 = 2173
  2. Sales ($mil) 12/2010 = 1687
  3. Sales ($mil) 12/2009 = 1183
  1. Annual EPS before NRI 12/2009 = 0.47
  2. Annual EPS before NRI 12/2010 = 0.61
  3. Annual EPS before NRI 12/2011 = 0.96

Dividend history

  1. Dividend Yield = 1.52
  2. Dividend Yield 5 Year Average 12/2011 = 0.7
  3. Dividend Yield 5 Year Average 09/2011 = 0.7
  4. Forward Yield = 1.52
  5. Dividend 5 year Growth 12/2011 = 37.41

Dividend sustainability

  1. Payout Ratio 06/2011 = 0.21
  2. Payout Ratio 5 Year Average 12/2011 = 0.14
  3. Payout Ratio 5 Year Average 09/2011 = 0.14
  4. Payout Ratio 5 Year Average 06/2011 = 0.14
  5. Change in Payout Ratio = 0.07

Performance

  1. Percentage Change Price 52 Weeks Relative to S&P 500 = 8.65
  2. Next 3-5 Year Estimate EPS Growth rate = 14.9
  3. EPS Growth Quarterly(1)/Q(-3) = -125
  4. ROE 5 Year Average 12/2011 = 6.59
  5. Return on Investment 06/2011 = 9.11
  6. Debt/Total Cap 5 Year Average 12/2011 = 6.25
  1. Current Ratio 06/2011 = 2.23
  2. Current Ratio 5 Year Average = 1.93
  3. Quick Ratio = 1.9
  4. Cash Ratio = 1.48
  5. Interest Coverage Quarterly = 12.38

Valuation

  1. Book Value Quarterly = 10.05
  2. Price/ Book = 1.44
  3. Price/ Cash Flow = 10.09
  4. Price/ Sales = 4.97
  5. EV/EBITDA 12 Mo = 8.93

Company: Lin Energy LLC (NASDAQ:LINE)

Basic Key ratios

  1. Percentage Held by Insiders = 1.95
  2. Relative Strength 52 weeks = 61
  3. Dividend 5-year Growth = 3.99
  4. Cash Flow 5 -year Average = 2.56
  5. Dividend Yield 5-Year Average = 9.75

Growth

  1. Net Income ($mil) 12/2011 = 438
  2. Net Income ($mil) 12/2010 = -114
  3. Net Income ($mil) 12/2009 = -298
  4. 12months Net Income this Quarterly/12 months Net Income 4Q's ago = 483.53
  5. Quarterly Net Income this Quarterly/same Quarter year ago = 22.14
  1. Cash Flow ($/share) 12/2011 = 3.8
  2. Cash Flow ($/share) 12/2010 = 3.08
  3. Cash Flow ($/share) 12/2009 = 3.31
  1. Sales ($mil) 12/2011 = 1162
  2. Sales ($mil) 12/2010 = 690
  3. Sales ($mil) 12/2009 = 273
  1. Annual EPS before NRI 12/2009 = 1.73
  2. Annual EPS before NRI 12/2010 = 1.54
  3. Annual EPS before NRI 12/2011 = 1.79

Dividend history

  1. Dividend Yield = 7.18
  2. Dividend Yield 5 Year Average 12/2011 = 9.75
  3. Forward Yield = 7.18
  4. Dividend 5 year Growth 12/2011 = 3.99

Dividend sustainability

  1. Payout Ratio 06/2011 = 1.53
  2. Payout Ratio 5 Year Average 12/2011 = 1.94
  3. Payout Ratio 5 Year Average 09/2011 = 1.94

Performance

  1. Percentage Change Price 52 Weeks Relative to S&P 500 = -4.82
  2. Next 3-5 Year Estimate EPS Growth rate = 4.9
  3. ROE 5 Year Average 12/2011 = 5.62
  4. Return on Investment 06/2011 = 4.88
  5. Debt/Total Cap 5 Year Average 12/2011 = 44.94
  1. Current Ratio 06/2011 = 1.26
  2. Current Ratio 5 Year Average = 1.9
  3. Quick Ratio = 1.26
  4. Cash Ratio = 0.68
  5. Interest Coverage = 2.70

Company: Atlas Pipeline Partners (NYSE:APL)

Levered Free Cash Flow = -118.20M

Basic Key ratios

  1. Percentage Held by Insiders = 0.37
  2. Market Cap ($mil) = 1984

Growth

  1. Net Income ($mil) 12/2011 = 289
  2. Net Income ($mil) 12/2010 = 276
  3. Net Income ($mil) 12/2009 = 60
  1. Cash Flow ($/share) 12/2011 = 3.01
  2. Cash Flow ($/share) 12/2010 = 0.87
  3. Cash Flow ($/share) 12/2009 = 1.79
  1. Sales ($mil) 12/2011 = 1303
  2. Sales ($mil) 12/2010 = 936
  3. Sales ($mil) 12/2009 = 904
  1. Anl EPS before NRI 12/2009 = -0.13
  2. Anl EPS before NRI 12/2010 = -0.65
  3. Anl EPS before NRI 12/2011 = 1.3

Dividend history

  1. Div Yield = 6.3%
  2. 5 year dividend growth rate= 7.26%
  3. Forward Yield = 6.30

Dividend sustainability

  1. Payout Ratio = 0.34
  2. Payout Ratio 5 Yr Average 09 09/2011 = 1.79

Performance

  1. Percentage Change Price 52 Wks Relative to S&P 500 = 23.43
  2. Average EPS Surprise Last 4 Qtr = 168.66
  3. EPS % Change F2/F1 = 83.05
  4. 5 Yr Historical EPS Growth 09/2011 = 5.98
  1. ROE 5 Yr Average 0909/2011 = 6.98
  2. Return on Investment 09/2011 = 9.37
  3. Debt/Tot Cap 5 Yr Average 09/2011 = 49.19
  1. Current Ratio 09/2011 = 0.77
  2. Current Ratio 5 Yr Average = 0.73
  3. Quick Ratio = 0.77
  4. Interest Coverage =10.3

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: ArcelorMittal Our Favorite Among 5 Plays For Selling Naked Puts

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.