I make extensive use of options in managing my portfolio. A sound option strategy can help an investor manage risk, pick up premium and/or get lower entry points into stocks that are already attractive. I find them very useful for times when I think the market is likely to be flat or slightly down in the near term as I currently do with U.S. equities. I particularly like selling slightly out of the money puts on stocks with low valuations and strong balance sheets but with no visible near term catalysts. I either pick up premium or get a lower price point on the stock I already like at current levels. One stock that seems to fit this strategy perfectly right now is Cisco Systems (CSCO).
Option Strategy: Sell the October 2012 16 puts on CSCO for $1.15
Outcome 1: Cisco stays above $16 at the expiration of the option on October 19th and the investor picks up the $1.15 premium for an annual return of over 17%
Outcome 2: Cisco dips below $16 and the stock gets "put" to the investor for a cost adjusted $14.85 ($16 - $1.15).
"Cisco Systems designs, manufactures, and sells Internet protocol based networking and other products related to the communications and information technology industry worldwide" (Business description from Yahoo Finance)
4 reasons Cisco is unlikely to go below $16 a share for any length of time:
- Cisco is selling at the very bottom of its five year valuation range based on P/E, P/CF, P/B and P/S.
- The company has an A+ rated balance sheet with approximately $6 a share in net cash on the books. It also yields 2%.
- The stock sells for just 8.5 times forward earnings, a substantial discount to its five year average (14.1)
- CSCO is quite a bit under consensus price targets. The 36 analysts that cover the stock have a median price target of $21.50. After the cautious guidance provided by the company on its last earnings call, Credit reiterated its "Outperform" rating and $27 price target on CSCO based on its low valuation and its competitive position.
Disclosure: I am long CSCO.