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 naked 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 like American Capital Agency (AGNC):
- They have a very savvy management team that has so far done an excellent job in terms of looking out for shareholder's interests. As of its public offering in May 2008, it has paid over $1.3 billion in dividends.
- AGNC uses swaptions to protect itself against lower interest rates that might lead to early prepayment.
- An excellent yield of 16.10%
- A strong quarterly revenue growth rate of 362%
- Profit margins of 92%
- A good five year ROE average of 18%
- Operating margins of 93%
- An excellent quarterly earnings growth rate of 387%
- Projected year over year growth rate for 2012 of 10.89%
- Net income soared from $119 million in 2009 to $770 million in 2011
- A strong relative strength score of 74 out of a possible 100
- A good interest coverage ratio of 7.00
- By investing exclusively in fixed rate agency securities that are implicitly guaranteed by the U.S. government its credit risk is limited
- $100K invested since its inception would have grown to over $250K; if the dividends were reinvested the rate of return would be much higher.
Suggested Put strategy for American Capital Agency:
It has fairly strong support in the 30-31 ranges and as the markets are in a corrective phase, there is a pretty decent chance that it could test these ranges. We would sell puts if and when it tests these ranges with strikes ranging from 28-30. Currently, it is trading at 32.27, and the Dec 2012 32 puts are trading in the 3.20-3.60 ranges with the last trade at 3.30. If it trades down to 30 then the Dec 30, 2012 puts would trade roughly in the same the range. If it takes more than a month to get down to this target, investors could always sell the Jan 13 puts. For this example, we will assume that we are able to sell the Dec 30 puts for 3.00 when AGNC trades down to 30. For each contract sold $300 will be deposited in your account. If it trades below 30, the shares could be assigned to you, and your final cost would be 27.00 (30.00-3.00). If it does not trade below 30 you get to keep the premium which works out to a lovely gain of 10%. This is far higher than the dividends most stocks pay out in a year.
Important facts investors should be aware in regards to investing and REITs:
Payout ratios are not that important when it comes to REITs as they are required by law to pay a majority of their cash flow as dividends. Payout ratios are calculated by dividing the dividend rate by the net income per share, and this is why the payout ratio for REITs is often higher than 100%. The more important ratio to focus on is the cash flow per share. If one focuses on the cash flow, one will see that in most cases, it exceeds the dividend declared per share.
Other interesting companies
For investors looking for additional ideas, we have provided detailed data on four additional companies. Our latest article could also prove to be a source of some new ideas - Kinder Morgan Energy Partners: A Splendid Long Term Play.
Company: First City Financial (FCFC)
Basic Key ratios
- Percentage Held by Insiders = 18.89
- Relative Strength 52 weeks = 87
- Cash Flow 5 -year Average = 0.54
- Net Income ($mil) 12/2011 = 24
- Net Income ($mil) 12/2010 = 13
- Net Income ($mil) 12/2009 = 19
- Net Income Reported Quarterly ($mil) = 15
- EBITDA ($mil) 12/2011 = 58
- EBITDA ($mil) 12/2010 = 58
- EBITDA ($mil) 12/2009 = 47
- Cash Flow ($/share) 12/2011 = 2.57
- Cash Flow ($/share) 12/2010 = 1.25
- Cash Flow ($/share) 12/2009 = 1.62
- Sales ($mil) 12/2011 = 74
- Sales ($mil) 12/2010 = 86
- Sales ($mil) 12/2009 = 80
- Annual EPS before NRI 12/2007 = 0.19
- Annual EPS before NRI 12/2008 = -2.19
- Annual EPS before NRI 12/2009 = 1.18
- Annual EPS before NRI 12/2010 = 0.84
- Annual EPS before NRI 12/2011 = 2.33
- EPS Growth Quarterly(1)/Q(-3) = 3-108.33
- ROE 5 Year Average 12/2011 = 1.3
- Current Ratio 06/2011 = 0.44
- Current Ratio 5 Year Average = 0.34
- Quick Ratio = 0.4
- Cash Ratio = 0.19
- Interest Coverage Quarterly = 4.47
Company: Caterpillar Inc (CAT)
Basic Key ratios
- Percentage Held by Insiders = 0.59
- Number of Institutional Sellers 12 Weeks = 4
- Net Income ($mil) 12/2011 = 4928
- Net Income ($mil) 12/2010 = 2700
- Net Income ($mil) 12/2009 = 895
- EBITDA ($mil) 12/2011 = 10474
- EBITDA ($mil) 12/2010 = 7303
- EBITDA ($mil) 12/2009 = 4339
- Cash Flow ($/share) 12/2011 = 11.95
- Cash Flow ($/share) 12/2010 = 7.91
- Cash Flow ($/share) 12/2009 = 5.94
- Sales ($mil) 12/2011 = 60138
- Sales ($mil) 12/2010 = 42588
- Sales ($mil) 12/2009 = 32396
- Annual EPS before NRI 12/2007 = 5.37
- Annual EPS before NRI 12/2008 = 5.66
- Annual EPS before NRI 12/2009 = 2.18
- Annual EPS before NRI 12/2010 = 4.19
- Annual EPS before NRI 12/2011 = 7.81
- Dividend Yield = 2.00
- Dividend Yield 5 Year Average 12/2011 = 2.63
- Dividend 5 year Growth 12/2011 = 6.69
- Payout Ratio 09/2011 = 0.22
- Payout Ratio 5 Year Average 12/2011 = 0.39
- 5 Year History EPS Growth 12/2011 = 2.76
- ROE 5 Year Average 12/2011 = 33.87
- Return on Investment 12/2011 = 13.87
- Current Ratio 12/2011 = 1.39
- Current Ratio 5 Year Average = 1.34
- Quick Ratio = 0.83
- Cash Ratio = 0.2
- Interest Coverage Quarterly = 8.25
We still believe there is more downside to this market before multi month bottom takes hold. 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 Kimberly Clark: A Great Strategy To Potentially Double your yield.
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. Consensus estimate table sourced from reuters.com.