Selling naked puts is a great way to purchase shares in companies you like at a predetermined price. In essence, you are getting paid to wait.
Benefits associated with selling puts
- In essence, you get paid for entering a "limit order" for a stock or stocks you would not mind owning.
- It allows one to generate income in a neutral or rising market.
- When you sell a naked put you are in a way acting like an insurance agent. The seller of the option agrees to buy the stock in the future if it drops to a certain level before the option expires. For this, you (the seller) are paid a premium upfront. If this strategy is repeated over and over again these premiums can really help boost you returns over time.
- 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.
- 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 if it trades below the strike price. 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 would be deposited in your account.
- 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. Time decay is the greatest in the front month.
Reasons to be bullish on Kimberly Clark (KMB):
- It is one of the leading manufacturers of health and hygiene products in the world with revenues in excess of $20 billion.
- A decent dividend yield of 3.7%.
- A very good levered free cash flow of $1.95 billion.
- A stellar record of consecutively increasing dividends for 37 years.
- A strong quarterly earnings growth rate of 33%.
- Cash flow per share increased from $6.62 in 2009 to $7.63 in 2011.
- It has an excellent record of returning cash to shareholders via consistent dividend payments. From 2008-2011, the company utilized cash reserves of $950 million, $986 million, $1.06 billion and $1.09 billion respectively towards dividends.
- Annual EPS before NRI increased from $4.24 in 2007 to $4.80 in 2011.
- Year over year projected growth rates of 7.3% and 7.4% for 2012 and 2013 respectively.
- A 5 year dividend growth rate of 7.3%.
- A good payout ratio of 58%.
- In 2011 it purchased roughly 19 million shares at a cost of $1.24 billion and in 2012 it expects to repurchase roughly $900 million-1.1 billion worth of shares.
- A projected EPS growth rate for the next 3-5 years of 6.5%.
- A good interest coverage ratio of 8.56.
- A decent free cash flow yield of 5.4%.
- Its cost-cutting program known as FORCE (focused on reducing costs everywhere) has led to savings of $240 million in 2009, $370 million in 2010 and over $260 million in 2011. It expects to save an additional $150-$200 million in 2012.
- $100K invested for 10 years would have grown to $207. If dividends were reinvested the rate of return would be much higher.
Suggested put (naked or cash secured) strategy:
Its trading close to its 52-week highs so we would wait until it trades down to the 70-72 ranges before selling puts. It is currently trading in the 78.68 ranges, and the Jan 2013 75 puts are trading in the 3.20-3.40 ranges. So if it trades down to the 70.50-71.00 ranges, we can roughly assume that the Jan 2013 68 puts will trade roughly in the same ranges. For this example, we will assume that the Jan 2013 68 puts are sold at a slightly lower price of 3.00. For each contract sold 300 will be deposited in your account. If the stock trades below 68 the shares will be assigned to your account; your final cost will be 65.00 (68.00-3.00). If the stock does not trade below 68 you get to keep the premium which works out to a gain of 7.35%, which is more than double Kimberly Clark's current yield of 3.7%.
If you bullish on this stock at current prices you can change the strategy and sell puts at strikes you would not mind owning the stock at. This strategy provides one with the option of lowering one's entry price. If you are bullish on the stock and would not mind owning it at a lower price you are in a win-win situation. You win if the shares are assigned to you, and you win even if they are not assigned as you get paid for waiting via the premium you received when you sold the puts.
Other interesting companies
For investors looking for other investment ideas, detailed data has been provided on two additional companies. Additionally, investors can draw some ideas from our latest article: Frontier Communications A Perfect Candidate For A Squeeze.
Company: Visa Inc-A (V)
Levered Free Cash Flow = $2.46B
- Net Income ($mil) 12/2011 = 3650
- Net Income ($mil) 12/2010 = 2966
- Net Income ($mil) 12/2009 = 2353
- EBITDA ($mil) 12/2011 = 7856
- EBITDA ($mil) 12/2010 = 6535
- EBITDA ($mil) 12/2009 = 5575
- Cash Flow ($/share) 12/2011 = 6.97
- Cash Flow ($/share) 12/2010 = 5.65
- Cash Flow ($/share) 12/2009 = 4.34
- Sales ($mil) 12/2011 = 9188
- Sales ($mil) 12/2010 = 8065
- Sales ($mil) 12/2009 = 6911
- Annual EPS before NRI 12/2008 = 2.25
- Annual EPS before NRI 12/2009 = 2.92
- Annual EPS before NRI 12/2010 = 3.91
- Annual EPS before NRI 12/2011 = 4.99
- Dividend Yield = 0.8
- Dividend 3 year Growth =30%
- Payout Ratio 06/2011 = 0.17
- Next 3-5 Year Estimate EPS Growth rate = 16.43
- EPS Growth Quarterly(1)/Q(-3) = -121.14
- ROE 5 Year Average 06/2011 = 11.12
- Current Ratio 06/2011 = 2.82
- Quick Ratio = 2.66
- Interest Coverage Quarterly = 162.7
Company: Pennant Park Investment Corporation (PNNT)
- Net Income ($mil) 12/2011 = 10
- Net Income ($mil) 12/2010 = 17
- Net Income ($mil) 12/2009 = 36
- EBITDA ($mil) 12/2011 = 4
- EBITDA ($mil) 12/2010 = 12
- EBITDA ($mil) 12/2009 = 33
- Cash Flow ($/share) 12/2011 = 1.01
- Cash Flow ($/share) 12/2010 = 0.88
- Cash Flow ($/share) 12/2009 = 0.78
- Sales ($mil) 12/2011 = 92
- Sales ($mil) 12/2010 = 60
- Sales ($mil) 12/2009 = 45
- Annual EPS before NRI 12/2007 = 0.35
- Annual EPS before NRI 12/2008 = 0.35
- Annual EPS before NRI 12/2009 = 1.08
- Annual EPS before NRI 12/2010 = 1.09
- Annual EPS before NRI 12/2011 = 1.25
- Dividend Yield = 11.70
- Dividend Yield 5 Year Average 12/2011 = 11.54
- Dividend 5 year Growth 12/2011 = 8.53
- Payout Ratio 06/2011 = 0.88
- Next 3-5 Year Estimate EPS Growth rate = 10
- EPS Growth Quarterly(1)/Q(-3) = -103.13
- ROE 5 Year Average 12/2011 = 9.35
- Current Ratio 06/2011 = 0.91
- Current Ratio 5 Year Average = 0.95
- Quick Ratio = 1.14
- Interest Coverage Quarterly = 2.6
The markets are extremely oversold and it looks like Monday's rally might be the beginning of the relief rally we have been expecting. However, we still believe there is more downside to this market. Long-term investors can use strong pullbacks to slowly start deploying money into long-term investments. A great way to get into a stock at a price of your choosing is to sell puts at strikes you would not mind owning the stock at. Investors looking for even more investment ideas might find these articles to be of interest: General Electric: An Option Strategy That Could Potentially triple your yield and Johnson & Johnson 1 Of 5 Long-Term Prospects To Consider.
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.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: EPS and Price Vs industry charts obtained from zacks.com. A major portion of the historical data used in this article was obtained from zacks.com. Data for Ycharts sourced from Ycharts.com Option table sourced from yahoo finance.